Baeyer's father was a member of the Prussian General Staff and his mother was the daughter of a celebrated jurist and literary historian. Born in Berlin, Baeyer went to Heidelberg in 1856 to study chemistry with Robert Bunsen. Here he met August Kekulé, who had a profound influence on his development as a chemist and gave him the theoretical foundation for his work. After obtaining his PhD (1858) Baeyer took up a teaching position in 1860 at a small technical school, the Gewerbe-Institute, in Berlin. In 1872 he was appointed professor of chemistry at Strasbourg and in 1875 succeeded Liebig as professor of chemistry at Munich, where he remained for the rest of his life.

In 1864, continuing the work of Wöhler, Liebig, and Schlieper on uric acid, Baeyer characterized a related series of derivatives including alloxan, parabanic acid, hydantoin, and barbituric acid. In 1871 he discovered the phthalein dyes, phenolphthalein and fluorescein, by heating phenols with phthalic anhydride. In the course of this work he discovered the phenol–formaldehyde resins, which were later developed commercially by Baekeland. The centerpiece of Baeyer's prolific researches, however, was his work on indigo, which started in 1865 and lasted for 20 years. In 1883 he gave a structure of indigo that was correct except for the stereochemical arrangement of the double bond, which was later shown to be trans by x-ray crystallography (1928). Baeyer's syntheses proved too costly for commercial manufacture and he took no part in the industrial development of indigo, terminating his work in 1885. Commercial synthetic indigo was eventually produced in 1890. Baeyer's work also led to the production of many other new dyes.

From indigo Baeyer turned to the polyacetylenes, compounds whose explosive properties led him to consider the stability of carbon–carbon bonds in unsaturated and ring compounds. He formulated the Baeyer strain theory, stating that compounds are less stable the more their bond angles depart from the ideal tetrahedral arrangement. Baeyer's other researches included work on oxonium compounds; on the reduction of aromatic compounds, in which he observed a loss of aromaticity on reduction; and on terpenes, including the first synthesis of a terpene in 1888.

The strain theory was one of Baeyer's few theoretical contributions; he was a virtuoso of test-tube chemistry at a time when this could produce extraordinary results. In 1905 he received the Nobel Prize for chemistry for his work on indigo and aromatic compounds.