Near Erhai Lake,The Kingdom of Nanzhao (南诏) was founded in 737 on the back of a complementary and successful alliance between Bai farmers and Yi nobles. During the apex of its power in the early 9th Century, Nanzhao's territory covered almost all of modern-day Yunnan, as well as northern portions of Burma, Thailand and Laos.

Conquering Chengdu and the important food production capacity of the Sichuan Basin was Nanzhao's crowning achievement, but also contained the seeds of its downfall. The Tang Dynasty that was ruling China at the time could not brook such a loss and focused much of its military might on reclaiming Sichuan and pushing Nanzhao's borders back. By 902 Nanzhao had fallen apart and was overthrown.

In 937 the Kingdom of Dali was founded by Duan Siping (段思平). This kingdom never reached the heights of power enjoyed by the Nanzhao, but it did last longer, surviving until 1253, when it was overrun by invading Mongol forces and incorporated into Yunnan province, which fell under the authority of the Mongol-ruled Yuan Dynasty. Most of the records of the Nanzhao era were destroyed by Mongol forces and for all intents and purposes Dali and Yunnan were never to be fully independent again.

Over the following centuries, Dali remained an important trading town on the Ancient Tea and Horse Road, an extensive trading network connecting Han China with Tibet, Southeast Asia and India – with Dali and Yunnan at the center of it all. Dali was often the northernmost stop for tea traders coming up from southern Yunnan and an eastern stopping point for Tibetans coming down with herbal medicines, salt and yak products.

Dali was also a major horse market for the ancient trade route. Horses were raced during the annual Third Moon Fair (三月街) that is still held between the old town and the mountains, drawing tens of thousands of visitors from around Yunnan and northern Southeast Asia.

The old town of Dali was originally built in the 15th Century under rule by the Ming Dynasty. What you see in Dali Old Town today is the rebuilt Ming town. Since then, the fortunes of Dali have declined and its importance as a cultural and economic centre in the Yunnan area have been overtaken by Kunming, the provincial capital.

1856-1872 Dali was the headquarters of the Panthay Rebellion led by Du Wenxiu. That rebellion commenced as an uprising against local oppressive rulers by the Hui Muslim minority and ended as open rebellion against the Qing Dynasty. The Palace of Du Wenxiu is on Fuxing Road and serves as the local museum (the museum exhibition on the rebellion paints it as a patriot workers revolt which it was not). The rebellion was brutally crushed by the Qing and hundreds of thousands of Yunnan Muslims were killed in revenge.