McDonald passed a medical at Molineux on Wednesday before putting pen to paper and manager Kenny Jackett is delighted to have secured his services.
"At 24, Kevin has already had good experience at both Burnley and Sheffield United, but is also a player with his best years ahead of him," Jackett told the club's official website.
"He is a ball-playing midfielder who is composed on the ball in possession and I am very pleased that we have added him to the squad.
"He is my second signing since arriving at the club, and I feel that in that midfield area he will prove a crucial one."
Chief executive Jez Moxey added: "We have said we have been trying to bring in players to strengthen the squad and are pleased to have completed a deal for Kevin.
"He is a player with a good track record and more potential to come and will prove a valuable addition to the squad."