Wide-spectrum caspase inhibition by the baculoviral p35 protein was previously shown to be a consequence of covalent inhibition in which a thioester bond is stably formed between the cleavage residue Asp87 of p35 and the active site Cys360' of caspase-8. Here we show that the N-terminal fragment of cleaved p35 (p35-N) is a circular peptide when dissociated from the caspase. Biochemical and crystallographic data suggest that p35-N circularization results from the trapping of a native chemical ligation intermediate in the p35/caspase complex, in which the N-terminal Cys2 of p35 attacks the Asp87-Cys360' thioester to form an equilibrium between Asp87-Cys2 and Asp87-Cys360'. This provides a crucial covalent interaction for keeping the N terminus of p35 bound in the caspase active site, which explains the absolute requirement of Cys2 for caspase inhibition. Participation of native chemical ligation in caspase inhibition by p35 illustrates an unusual mechanism of protease inhibition.