A new approach for the preparation of palladium nanoparticles in water from a renewable source, 2-hydroxypropyl-α-cyclodextrin (α-HPCD), which acts both as a reductant and capping agent, is presented. The palladium nanoparticles were characterized by using dynamic light scattering (DLS), transmission electron microscopy (TEM) and X-ray photoelectron spectroscopy (XPS), which revealed the formation of spherical particles in the size range of 2–7 nm. Further analysis by Fourier-transform infrared spectroscopy (FT-IR) and 1H NMR did not show covalent bonds between cyclodextrins and palladium nanoparticles, suggesting that α-HPCD is only physically adsorbed on the nanoparticle surface, presumably through hydrophobic interactions which limit the mutual coalescence of nanoclusters. The catalytic activity was tested in Suzuki, Heck and Sonogashira reactions in neat water, providing good yields and selectivities of coupling products under very low Pd loadings (0.5–0.01 mol%). Remarkably, the nanocatalyst showed significant stability hence the aqueous phase remained active for four subsequent runs. The combination of a binding site for substrates (the HPCD cavity) and a reactive centre (Pd core) provides a potential to explore functional catalysis in aqueous medium.