The Caps signed the Lloydminster, Saskatchewan, native to a five-year, $30.5 million contract, the team announced.
The deal came a day after an arbitration hearing in Toronto.
"It was hard for both sides to put apples-to-apples comparisons on the comparable goaltenders," general manager Brian MacLellan said. "In the arbitration process, both sides present their stories. You get a better sense of where each side is at and where you can compromise. And that's what happened."
According to reports, Holtby had requested $8 million in arbitration, while the Caps had countered with $5.1 million. A decision from the case arbiter would have been made by Saturday, though the two sides managed to avert that scenario.
Holtby's 2014-15 season was an exceptional one, as he set highs in wins (41), shutouts (9), games played (73), goals-against average (2.22) and save percentage (.973) for his career. He also tied a franchise record in wins, shutouts and games played.
Beyond that, the goalie was a wall in the postseason, posting a dazzling 1.71 goals-against average and a .944 save percentage in 13 playoff games for the Caps before they were eliminated in the Eastern Conference semifinals by the New York Rangers.
"With last year it was trying to prove yourself for a contract," said Holtby, a fourth-round pick by the Capitals in 2008. "This year, you're trying to prove the contract you got. Obviously, it's going to be a new set of challenges. The low points of seasons are going to be a little harder to get through because of the added pressure."
Holtby's contract will count $6.1 million against the salary cap over the next five seasons.
"He's a perfect fit for what we think we have," MacLellan said. "He fits well with his teammates, fits well with the defensemen. The coaches like him. I don't know what the ceiling is on him, but you know he has the right attitude and the right work ethic. Obviously we think we have a chance to win a championship with him."
The Capitals also added a defenseman Friday, signing Ryan Stanton to a one-year, two-way contract. He scored 11 points in 54 games with Vancouver last season. The 26-year-old has 119 career NHL games with the Canucks and Chicago.
The Associated Press contributed to this report.