Yellowknife was first settled in 1935, after gold had been found in the area; Yellowknife soon became the centre of economic activity in the NWT, and became the capital of the Northwest Territories in 1967. As gold production began to wane, Yellowknife shifted from being a mining town to being a centre of government services in the 1980s. However, with the discovery of diamonds north of Yellowknife in 1991, this shift has begun to reverse.

Traditionally, First Nations people had occupied this region; by the 1930s they had a settlement on a point of land on the east side of Yellowknife Bay, Dettah. The current municipal area of Yellowknife was occupied by prospectors who ventured into the region in the mid-1930s.

A Klondike-bound prospector, B.A. Blakeney, made the first discovery of gold in the Yellowknife Bay area in the late 19th century. The discovery was viewed as unimportant in those days because of the Klondike Gold Rush and because Great Slave Lake was too far away to attract attention.

In the late 1920s, aircraft were first used to explore Canada's Arctic regions. Samples of uranium and silver were uncovered at Great Bear Lake in the early 1930s, and prospectors began fanning out to find additional metals. In 1933 two prospectors, Herb Dixon and Johnny Baker, canoed down the Yellowknife River from Great Bear Lake to survey for possible mineral deposits. They found gold samples at Quyta Lake, about 30 km (19 mi) up the Yellowknife River, and some additional samples at Homer Lake.

The following year, Johnny Baker returned as part of a larger crew to develop the previous gold finds and search for more. Gold was found on the east side of Yellowknife Bay in 1934 and the short-lived Burwash Mine was developed. When government geologists uncovered gold in more favourable geology on the west side of Yellowknife Bay in the fall of 1935, a small staking rush occurred. Con Mine was the most impressive gold deposit and its development created the excitement that led to the first settlement of Yellowknife in 1936–1937; the mine entered production on September 5, 1938.

The population of Yellowknife quickly grew to 1,000 by 1940, and by 1942, five gold mines were in production in the Yellowknife region. However, by 1944, gold production had ground to a halt as men were needed for the war effort. An exploration program at the Giant Mine property on the north end of town had suggested a sizable gold deposit in 1944. This new find resulted in a massive post-war staking rush to Yellowknife. It also resulted in new discoveries at the Con Mine, greatly extending the life of the mine. The Yellowknife townsite expanded from the Old Town waterfront, and the new townsite was established during 1945–1946. The Discovery Mine, with its own townsite, operated 81 km (50 mi) to the north-northeast of Yellowknife from 1950 to 1969.

Between 1939 and 1953, Yellowknife was controlled by the Northern Affairs department (now Indian and Northern Affairs Canada) of the Government of Canada. A small council, partially elected and partially appointed, made decisions. By 1953, Yellowknife had grown so much that it was made a municipality, with its own council and town hall. The first mayor of Yellowknife was John "Jock" McNiven. In September 1967, Yellowknife officially became the capital of the Northwest Territories. This important new status sparked what has been coined as the third boom in Yellowknife. New sub-divisions were established to house an influx of government workers.

In 1978 the Soviet nuclear-powered satellite Kosmos 954 crashed to Earth near Yellowknife. There were no known casualties, although a small quantity of radioactive nuclear fuel was released into the environment, and Operation Morning Light—an attempt to retrieve it—was only partially successful. A new mining rush and fourth building boom for Yellowknife began with the discovery of diamonds 300 km (190 mi) north of the city in 1991. The last of the gold mines in Yellowknife closed in 2004. Today, Yellowknife is primarily a government town and a service centre for the diamond mines. On April 1, 1999, its purview as capital of the NWT was reduced when the territory of Nunavut was split from the NWT. As a result, jurisdiction for that region of Canada was transferred to the new capital city of Iqaluit. Consequently, Yellowknife lost its standing as the Canadian capital city with the smallest population.

Yellowknife has a subarctic climate and averages less than 300 mm (12 in) of precipitation annually, as the city lies in the rain shadow of mountain ranges to the west. Thanks to its location on Great Slave Lake, Yellowknife has a frost-free growing season that averages slightly over 100 days. Most of the limited precipitation falls between June and October, with April being the driest month of the year and August being the wettest. Snow that falls in winter accumulates on the ground until the spring thaw.

Yellowknife is located on the Canadian Shield, which was scoured down to rock during the last ice age. The surrounding landscape is very rocky and slightly rolling, with many small lakes in addition to the larger Great Slave Lake. Trees such as pine and birch are abundant in the area, as are smaller bushes, but there are also many areas of relatively bare rock with lichen. Yellowknife's high latitude causes a large variation between day and night. Daylight Hours range from five hours of daylight in December to twenty hours in June. Twilight lasts all night from late May to early July.