Terbinafine hydrochloride, although one of the prominent antifungal agents, suffers from low drug permeation owing to its hydrophobic nature. The approach of nanosponge formulation may thus help to resolve this concern. Thus, the present research was envisioned to fabricate the nanosponge hydrogel of terbinafine hydrochloride for topical delivery since nanosponge augments the skin retentivity of the drug. The optimized formulation was obtained using Box Behnken Design. The dependent and independent process parameters were also determined wherein polyvinyl alcohol (%), ethylcellulose (%), and tween 80 (%) were taken as independent process parameters and particle size, polydispersity index (PDI), and entrapment efficiency (EE) were the dependent parameters. The nanosponge was then incorporated into the hydrogel and characterized. In-vitro drug release from the hydrogel was 90.20 ± 0.1% which was higher than the drug suspension and marketed formulation. In vitro permeation potential of the developed formulation through rat skin showed a flux of 0.594 ± 0.22 µg/cm2/h while the permeability coefficient was 0.059 ± 0.022 cm/s. Nanosponge hydrogel was evaluated for non-irritancy and antifungal activity against C. albicans and T. rubrum confirming the substantial outcome. Tape stripping studies exhibited ten times stripping off the skin quantified 85.6 ± 0.21 μg/cm2. The confocal analysis justified the permeation potential of the prepared hydrogel. The mean erythemal score was 0.0, confirming that the prepared hydrogel did not cause erythema or oedema. Therefore, based on results obtained, nanosponge hydrogel formulation is a potential carrier for efficient topical delivery of terbinafine hydrochloride.