Ultrasonic-assisted electrolytic in-process dressing (UA-ELID) grinding is a promising technology that uses a metal-bonded diamond grinding wheel to achieve a mirror surface finish on hard and brittle materials. In this paper, the UA-ELID grinding was applied to nanocomposite ceramic for investigating the cavitation effect on the processing performance. Firstly, the ultrasonic cavitation theory was utilized to define the cavitation threshold, collapse of cavitation bubbles, and variation of their radii. Next, the online monitoring system was designed to observe the ultrasonic cavitation under different ultrasonic amplitude for the actual UA-ELID grinding test. A strong effect of ultrasonic cavitation on the grinding wheel surface and the formed oxide film was experimentally proved. Besides, under the action of ultrasonic vibration, the dressing effect of the grinding wheel was improved, and the sharpness of grain increased by 43.2%, and the grain distribution was dramatically changed with the increase of ultrasonic amplitude. Compared with the conventional ELID (C-ELID) grinding, the average protrusion height increased by 14.2%, while the average grain spacing dropped by 21.2%. The UA-ELID grinding reduced the workpiece surface roughness Rz and Ra by 54.2% and 46.5%, respectively, and increased the surface residual compressive stress by 44.5%. The surface morphology observation revealed a change in the material removal mechanism and improvement of the surface quality by ultrasonic cavitation effect. These findings are considered instrumental in theoretical and experimental substantiation of the optimal UA-ELID grinding parameters for the processing of nanocomposite ceramics.