Butterknowle lies in the Gaunless valley. There are no remains from the prehistoric or Roman period, though the area was undoubtedly occupied in this period. The village itself was probably not formed until the Anglo-Saxon period - the name of the village comes from the Old English for 'hill where the butter is made'.

Farming was the main occupation in Butterknowle until the growth of the coal industry. The earthwork remains near Potter's Cross may be the remains of a medieval farmstead or village. Although the first colliery is recorded here in around 1362, but it was not until the 19th century that coal mining became really important. The ruined remains of a 19th century engine house can still be seen. Most of the coal was burnt in coke ovens to make coke for use in the iron smelting industries.