The signals that determine whether axons are ensheathed or myelinated by Schwann cells have long been elusive. We now report that threshold levels of neuregulin-1 (NRG1) type III on axons determine their ensheathment fate. Ensheathed axons express low levels whereas myelinated fibers express high levels of NRG1 type III. Sensory neurons from NRG1 type III deficient mice are poorly ensheathed and fail to myelinate; lentiviral-mediated expression of NRG1 type III rescues these defects. Expression also converts the normally unmyelinated axons of sympathetic neurons to myelination. Nerve fibers of mice haploinsufficient for NRG1 type III are disproportionately unmyelinated, aberrantly ensheathed, and hypomyelinated, with reduced conduction velocities. Type III is the sole NRG1 isoform retained at the axon surface and activates PI 3-kinase, which is required for Schwann cell myelination. These results indicate that levels of NRG1 type III, independent of axon diameter, provide a key instructive signal that determines the ensheathment fate of axons.