Hypersecretion of acid hydrolases is a hallmark feature of mucolipidosis II (MLII), a lysosomal storage disease caused by loss of carbohydrate‐dependent lysosomal targeting. Inappropriate extracellular action of these hydrolases is proposed to contribute to skeletal pathogenesis, but the mechanisms that connect hydrolase activity to the onset of disease phenotypes remain poorly understood. Here we link extracellular cathepsin K activity to abnormal bone and cartilage development in MLII animals by demonstrating that it disrupts the balance of TGFß‐related signaling during chondrogenesis. TGFß‐like Smad2,3 signals are elevated and BMP‐like Smad1,5,8 signals reduced in both feline and zebrafish MLII chondrocytes and osteoblasts, maintaining these cells in an immature state. Reducing either cathepsin K activity or expression of the transcriptional regulator Sox9a in MLII zebrafish significantly improved phenotypes. We further identify components of the large latent TGFß complex as novel targets of cathepsin K at neutral pH, providing a possible mechanism for enhanced Smad2,3 activation in vivo. These findings highlight the complexity of the skeletal disease associated with MLII and bring new insight to the role of secreted cathepsin proteases in cartilage development and growth factor regulation. © 2015 American Society for Bone and Mineral Research.