The town of Bannack sprang up following the first great gold strike in Montana history at Grasshopper Creek, by the John White Party in July of 1862. The discovery was considered one of the greatest western gold rushes since the California Gold Rush of 1849. By the winter of 1862, the makeshift town of Bannack had a population of 500. The town was named for the Bannock Indians, the region's indigenous people. Bannack's population peaked in 1863, with more than 5,000 people settled in and around the town. Bannack was divided into two camps in its early years, reflecting the divisions among its settlers over the Civil War.

One of the most famous eras in Bannack's history was the tenure of the infamous Henry Plummer, as sheriff of Bannack and Virginia City, beginning in 1863. Plummer and his group of road agents, known as the "Innocents," held Bannack in their grip for a period of 16 months from Plummer's arrival in November 1862 until February of 1864. In that time, there were 102 documented murders by the road agents and an unknown but substantial number of robberies. The murder of Nicholas Thiebalt in December 1864 by road agent George Ives, was the beginning of the end for Henry Plummer and the Innocents. Following public outcry, Ives was prosecuted and summarily executed, at the direction of Colonel Wilbur Fisk Sanders, prosecutor and Bannack resident. After the execution of George Ives, the Vigilance Committee was organized to investigate and prosecute the members of Plummer's gang. After his capture by the vigilantes, road agent Red Yeager revealed Henry Plummer as the leader of the gang. The vigilantes hanged Plummer, Buck Stinson, and Ned Ray January 10, 1864. By February of 1864, the vigilantes hanged or banished a total of 32 people, with the support of the citizens of Bannack.

Bannack became the first capital of the newly created Montana Territory in 1864, chosen by territorial governor Sidney Edgerton. The first bicameral legislature met in Bannack for a period of 60 days. The legislature passed the first laws regarding roads, schools, voter eligibility, irrigation, and mining. One law passed by the first legislature, placed strict regulations on cattle brands, reflecting the influence of cattle ranching in the area by 1864. Governor Edgerton personally funded much of the costs for the fledgling government during his time in office, because the territory was without a secretary to sign warrants for federal funds. Edgerton resigned and left Montana in 1866 after a dispute with President Johnson. In 1865, Bannack's population had largely shifted to other sites, following strikes at Helena and Alder Gulches. The territorial capital was moved to the more populous Virginia City in 1865. Placer mining was replaced by dredging by the turn of the century. In the decades following, hydraulic replaced dredging operations. Mining operations still continue around Bannack, but the last residents left before WWII. Bannack became a state park in the 1970s, with an emphasis on preservation of the site as it had been between 1888 and 1900.