Serena, the reigning champion and winner of the French Open, has looked untouchable since the start of the tournament, and was unbeaten in 34 matches going into the last-16 clash.
But Lisicki, the 23rd seed with a strong record at Wimbledon in recent years, paid no heed to the form book and raced through the first set 6-2.
The champion roared back, levelling the match with a nine-game winning streak and taking an immediate break in the deciding set.
But once again Lisicki was not done, twice breaking back to get on terms in the third and then converting another to serve out at 5-4.
She spurned a match point, but took her second before breaking into tears in front of the rapturous Centre Court crowd.
"I didn't play the big points good enough," Serena reflected afterwards of her loss. "I had a little hesitation. That explains it."
She also added that Lisicki, a 23-year-old who is has now reached the last eight at Wimbledon for the fourth time, could not be considered a shock winner.
"Every time I step out on the court I'm the favourite. I've got used to that.
"[But] it's not a shock. She plays really good on grass. She has a massive serve so I went into it knowing it's not going to be an easy match."
After dropping just 11 games in the first week, her surprise exit, which mirrored those of former men's champions Roger Federer and Rafa Nadal last week, ended Williams's win streak at 34 matches and it was only her fourth loss in the last 76.
Lisicki took advantage of a somewhat sluggish Williams to seize the first set, her strong serve and fizzing groundstokes at times leaving the multiple grand slam winner rooted to the spot.
The American, aghast, annoyed and berating herself after each error, desperately searched for the missing aggression and from 1-0 down in the second, reeled off nine games in a row.
She made no unforced errors to breeze through the second set and appeared to have knocked the stuffing out of her reeling opponent.
But the doubts began to creep back into her game as each time she appeared to be in control, the German answered with breaks of her own before Williams dropped her serve to trail 5-4.
Williams saved one match point, then wasted a break point of her own before Lisicki sealed the biggest victory of her career with a rasping forehand winner.
Lisicki next meets Kaia Kanepi for a place in the semi-finals, after the Estonian overcame British hope Laura Robson 7-6(6) 7-5.
Li Na romped into the Wimbledon quarter-finals with a 6-2 6-0 victory over Roberta Vinci.
The 2011 French Open champion served for the first set at 5-0 up but was broken by the doubles specialist, who raised loud cheers on Court Three as she finally registered a game against her name on the scoreboard.
The 30-year-old Vinci, seeded 11th, held her next service game but from then on Li was an unstoppable force as she won the next seven games to reach the last eight at Wimbledon for the third time.
The Chinese favourite will next face 2012 runner-up Agnieszka Radwanska, who beat Bulgaria's Tsvetana Pironkova 4-6 6-3 6-3.
The Polish fourth seed proved too strong for her 76th-ranked Bulgarian opponent and last year's runner-up is the highest ranked woman in the last eight.
Radwanska, 24, looked listless and ill-at-ease on Court Two. Her serve lacked rhythm and she dropped it twice before getting a toe-hold in the set.
Admonishing herself for uncharacteristic errors, she saved four set points, two on her own serve, before succumbing to the Bulgarian's big forehand in a baseline rally.
But the former Wimbledon junior champion has an-all court-game that suits grass and she found her range in the second set, commanding the net and volleying with precision.
It was a low-key match in front of a subdued crowd which has become used to upsets after the first-week departures of Maria Sharapova, Victoria Azarenka and Sara Errani.
But Radwanska said she felt no great pressure as the highest seed standing
"It doesn't mean anything, especially here. So many weird scores," she said. "There's still a lot of players playing really great tennis. Every match is a different story. Doesn't matter what ranking they have."
Petra Kvitova flew the flag for former Wimbledon champions on Monday when she became the first to make the quarter-finals with a 7-6 6-3 win over doughty Spaniard Carla Suarez Navarro.
After the high-profile departures of Rafael Nadal, Roger Federer and Maria Sharapova in the first week - and then Williams - Kvitova sneaked through on a blustery Court Three before the main fourth-round action had started on the big show courts.
It was not all plain sailing for the 2011 champion, who has yet to rediscover the consistency that took her to world number two 20 months ago.
"I was pretty nervous today...I didn't play my best, especially in the first set. But it's important to win the last point which was what I did," Kvitova told a news conference.
Suarez Navarro, 24, the last Spanish woman in the draw, harried her from the baseline, moving fast, returning early and chasing down the Czech's booming groundstrokes.
She was watched in the stands by Fed Cup captain Conchita Martinez, the only Spanish woman to win the Wimbledon title when she beat Martina Navratilova in the 1994 final.
Eighth seed Kvitova, 23, broke the Spaniard's serve and should have finished off the first set in the 12th game but nervy shots allowed Suarez Navarro to break back, using her rare and elegant single-handed backhand to stinging effect.
With big names like the injured Victoria Azarenka and former world number one Caroline Wozniacki gone, Kvitova was clearly feeling the weight of expectation.
"Everybody is talking about that I'm the highest seeded player in my half, I'm supposed to be already in the final. It's not really easy to hear that," she said.
But the statuesque Czech's power eventually proved too much for her more diminutive opponent and she pressured Suarez Navarro into slapping a forehand into the net to take the set 7-5 in the tiebreak.
Emerging victorious from a tight tiebreak appeared to energise Kvitova and she bowled through the second set in 34 minutes, using her big left-handed serve, long reach and strength to quell her Spanish opponent.
Kvitova will play 20th seed Kirsten Flipkens in the quarter-finals on Tuesday after the Belgian overcame Flavia Pennetta.
"I lost against her last time in Miami. So I hope that I can play better tennis than in the last match," she said.
"We've never played on the grass, which is quite difficult."
American Sloane Stephens beat Monica Puig to reach her first Wimbledon quarter-final on Monday just as compatriot Serena Williams's defeat had thrown the draw wide open.
With fourth seed Agnieszka Radwanska in the other half, the 20-year-old Stephens is now being talked about as potential Wimbledon champion a bit sooner than expected.
The only American to reach the last eight of the men's or women's singles refused to be sucked in by the hype, though, after a 4-6 7-5 6-1 win over Puerto Rican Puig with whom she has trained with regularly at the same Florida base.
"I saw (Kirsten) Flipkens, she fell to the ground today. You would have thought she just won Wimbledon," Stephens, who reached the Australian Open semi-final this year having beaten Williams in Melbourne.
"I think I was just kind of the whole match really calm. I was happy to get the win, so I wasn't too like overjoyed."
Seventeenth seed Stephens has a few Grand Slam titles to win before comparisons with 16-times major champion Williams can be taken seriously but she lacks nothing in confidence.
She even accused Williams of "scaring people" and "intimidation" earlier this year in a Time magazine article.
Asked her reaction on Serena saying in her press conference that she could go on to win the title, Stephens offered an almost sarcastic "Thanks".
"I'm top 20 in the world for a reason," she said when asked about a recent return to form after a dip. "I didn't like all of a sudden snap my fingers and I got good.
"I put in a lot of work, took a lot of sweat, like bad hair days, all that other stuff, to get to where I was. I realise that I just couldn't let that go to waste."
Stephens, the highest-ranked of a growing bunch of American women in the top 100, said thoughts of winning the title had not yet entered her head, especially with former runner-up Marion Bartoli up next and then possibly 2011 champion Petra Kvitova.
"Playing a grand slam, every occasion is big, every quarter is big, even if you're playing like Timbuktu Court, Aorangi," she said.
"I'll go out and play hard. I'm looking forward to it. I'm excited. Hopefully I'll have a good match and have fun."
Round four results
23-Sabine Lisicki (Germany) beat 1-Serena Williams (U.S.) 6-2 1-6 6-4
4-Agnieszka Radwanska (Poland) beat Tsvetana Pironkova (Bulgaria) 4-6 6-3 6-3
6-Li Na (China) beat 11-Roberta Vinci (Italy) 6-2 6-0
8-Petra Kvitova (Czech Republic) beat 19-Carla Suarez Navarro (Spain) 7-6(5) 6-3
15-Marion Bartoli (France) beat Karin Knapp (Italy) 6-2 6-3
17-Sloane Stephens (U.S.) beat Monica Puig (Puerto Rico) 4-6 7-5 6-1
20-Kirsten Flipkens (Belgium) beat Flavia Pennetta (Italy) 7-6(2) 6-3
Kaia Kanepi (Estonia) beat Laura Robson (Britain) 7-6(6) 7-5
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- Agnieszka Radwanska