Nanoparticles of iron carbides (Fe3C and χ-Fe2.5C) wrapped in multilayered graphitic sheets were synthesized by a developed method in which an electric plasma was generated in an ultrasonic cavitation field containing thousands of tiny activated bubbles in liquid ethanol. Annealing changed the phase composition, structure, and size of the carbon nanocapsules as most of the iron carbides decomposed into the α-Fe phase and graphite. Powder samples annealed at 873 and 973 K have maximal saturation magnetization values equal to 80.6 and 83.4 A m2/kg, respectively, which is approximately 40% of the value of bulk iron. Using this method, it will be possible to synthesize nanoparticles of a metal of choice encapsulated by graphite shells by selecting appropriate materials for the ultrasonic tip and electrodes.