The 28-year-old left Stamford Bridge at the end of last season after failing to agree a new contract with the club and has agreed personal terms at Anfield.
The England midfielder will undergo a medical in the next 48 hours.
Cole was linked with a number of Premier League sides, including Arsenal and Tottenham, but has opted to move to Merseyside.
He could have gone to a team offering Champions League football but has chosen to join new Reds boss Roy Hodgson at Anfield even though they can only offer the Europa League this season.
The capture of Cole was seen as being a key factor in proving to the likes of Steven Gerrard and Fernando Torres, who have both been linked with departures after a disappointing seventh-placed finish in Rafael Benitez's final season in charge, that Liverpool can still compete for quality signings.
Cole is the second summer arrival at Liverpool after Serbia forward Milan Jovanovic joined following the expiration of his contract with Standard Liege.
Cole will be seen as a direct replacement for Yossi Benayoun, who coincidentally moved to Chelsea for £5.5million earlier this month, and only time will tell who got the better of that exchange.
Hodgson is still on the look-out for a new left-back with Fabio Aurelio having left and Emiliano Insua on the verge of completing his move to Fiorentina.
After that the Liverpool boss will hope to secure commitments from Gerrard and Torres about their futures.
Former Liverpool midfielder Jamie Redknapp, whose father Harry was keen on signing Cole for Spurs, said reports the player was holding out for the most lucrative contract were unfair.
"From what I know, compared to other players in the Premier League now, he's not being greedy at all," Redknapp told Sky Sports News.
"He just wants a good deal and rightfully so - he's a free agent and he's worked that situation nicely - but I know he's not asking for anything astronomical, like what is being portrayed in the press.
"He's just looking for the right club and he needs to play football now.
"He missed a lot of time at Chelsea last season with his knee injury and didn't quite get back to the level he showed previously.
"He needs to go somewhere, be loved, and play football and get back to being the Joe Cole we all know."