Walton, 22, joined the Blades from Plymouth Argyle for the season but damaged cruciate knee ligaments during his first pre-season outing.
The cancellation of the contract allows Gary Speed, the new Sheffield United manager, freedom to add to his squad with a loan signing.
One possible arrival at Bramall Lane is the Everton forward James Vaughan, who is believed to also be a target for Burnley, Derby County and Leicester City.