The world number 19 displayed an impressive performance on the blue clay court against the number two seed and managed to execute a number of powerful shots to overcome his fellow Spaniard and take the first set in just over an hour.
Nadal tried to stay in contention during the opening games but losing an early break of serve proved damaging for the 25-year-old, who won the Barcelona Open a fortnight ago.
Despite a dip in the early stages of the contest, Nadal found his feet on the controversial court surface and displayed a style of play that ensured a vital break of serve, which led him to grab the second set.
The former world number one began to take the match in his stride after the Spaniard forced the third-round tie into a deciding set, preventing Verdasco from imposing his game on the Madrid court.
Despite a positive comeback, Nadal's 28-year-old opponent put up a fight and managed to switch the game from a 4-2 lead in the world number two's favour to an astonishing 7-5 victory, which clinched a spot in the quarter-finals.