The area was originally a swampy bog at the foot of the small hills that border the town. In 1873 Sir William Gregory authorised the damming of the Thalagala stream, which originates from Mount Pidurutalagala, in order to make more land available for the expansion of the town. In 1881 the lake was stocked with trout by Mr C. J. R. Le Mesurier (Assistant Government Agent for Nuwara Eliya).
In 1913 the waters of the lake were directed into a tunnel which flows to a hydro power station at ‘Blackpool’ between the town and Nanu Oya. The power station continues to supply electricity to the town to this day. In British times Lake Gregory was used for water sports and recreational activities.