The 24-year-old singer, who found fame with N-Dubz, was arrested along with 35-year-old musician Mike GLC by appointment at a central London police station.
Their arrests came after the Metropolitan Police said its officers were ''considering'' information after a newspaper suggested Contostavlos had acted as a go-between in a drug deal by introducing a journalist to an alleged supplier.
The Sun On Sunday reported that half an ounce of cocaine changed hands as a result of the deal conducted at London's Dorchester Hotel.
After he was bailed, Mike GLC spoke outside Belgravia Police Station where he insisted the pair were innocent and denied he was a drug dealer.
The musician said: "We are innocent. We haven't been charged.
He added that any evidence caught on camera had been "taken out of context" and the duo were "set up".
"Anyone can edit or chop things together on video," he said.
"The truth will come out in the end. I don't want to go into much more detail.
"I am going home to be with my family. This is ruining my life.
"I am not a drug dealer. I have never sold drugs in my life."
A police spokesperson confirmed that they had released the pair on bailuntil next month.
"Officers from Westminster have today, Tuesday, June 4, arrested two people - a 35-year-old man and a 24-year-old woman - by appointment at a central London police station on suspicion of being concerned in the supply of Class A drugs.
"Both have now been bailed pending further inquiries to a date in late July. Searches have been completed at two residential addresses."
Contostavlos's spokesman declined to comment on today's developments.
The singer was officially dropped as a judge on 'The X Factor' just days ago, with Sharon Osbourne returning to the show in her place.
Contostavlos - whose debut solo album made it to only number 35 in the charts - won an apology last year from a former boyfriend who leaked footage on to the internet of the two of them performing a sex act.
A Metropolitan Police spokesman said on Tuesday: "Officers from Westminster have today, Tuesday June 4, arrested two people - a 35 year-old man and a 24-year-old woman - by appointment at a central London police station on suspicion of being concerned in the supply of class A drugs."
A police spokesman said later that a 24-year-old woman and 35-year-old man had been bailed to a date next month, adding that two residential properties were searched as part of the investigation.
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