Lacy began his career at sixteen playing Dixieland music with much older musicians such as Henry "Red" Allen, Pee Wee Russell, George "Pops" Foster and Zutty Singleton and then with Kansas City jazz players like Buck Clayton, Dicky Wells, and Jimmy Rushing. He then became involved with the avant-garde, performing on Jazz Advance (1956), the debut album of Cecil Taylor, and appearing with Taylor's groundbreaking quartet at the 1957 Newport Jazz Festival; he also made a notable appearance on an early Gil Evans album. His most enduring relationship, however, was with the music of Thelonious Monk: he recorded the first album to feature only Monk compositions (Reflections, Prestige, 1958) and briefly played in Monk's band in 1960 and later on Monk's Big Band/Quartet album (Columbia, 1963).
Monk tunes became a permanent part of his repertoire, making an appearance in virtually every concert appearance and on albums, and Lacy often collaborated with trombonist Roswell Rudd in presenting interpretations of Monk's compositions.
Beyond Monk, he performed the work of jazz composers such as Charles Mingus, Duke Ellington and Herbie Nichols; unlike many jazz musicians he rarely played standard popular or show tunes. Lacy also became a highly distinctive composer with a signature simplicity of style: a Lacy composition is often built out of little more than a single questioning phrase, repeated several times. In the 1960s he continued to work with other players involved in the American free-jazz avant-garde and, in the 1970s, the European free improvisation scene, and free improvisation remained an important element in his work thereafter.
Lacy's first visit to Europe came in 1965, with a visit to Copenhagen in the company of Kenny Drew; he went to Italy and formed a quartet with Italian trumpeter Enrico Rava and the South African musicians Johnny Dyani and Louis Moholo (their visit to Buenos Aires is documented on The Forest and the Zoo, ESP, 1967). After a brief return in New York, he returned to Italy, then in 1970 moved to Paris, where he lived until the last two years of his life. He became a widely respected figure on the European jazz scene, though he remained less well-known in the U.S.
The core of Lacy's activities from the 1970s to the 1990s was his sextet: his wife, singer/cellist Irene Aebi, soprano/alto saxophonist Steve Potts, pianist Bobby Few, bassist Jean-Jacques Avenel, and drummer Oliver Johnson (later John Betsch). Sometimes this group was scaled up to a large ensemble (e.g. Vespers, Soul Note, 1993), sometimes pared down to a quartet, trio, or even a two-saxophone duo. He played duos with pianist Eric Watson. Lacy also, beginning in the 1970s, became a specialist in solo saxophone; he ranks with Anthony Braxton and Evan Parker in the development of this demanding form of improvisation.
Lacy was interested in all the arts: the visual arts and poetry in particular became important sources for him. Collaborating with painters and dancers in multimedia projects, he made musical settings of his favourite writers: Robert Creeley, Samuel Beckett, Tom Raworth, Taslima Nasrin, Herman Melville, Brion Gysin and other Beat writers, including settings for the Tao Te Ching and haiku poetry. As Creeley noted in The Poetry Project Newsletter, "There’s no way simply to make clear how particular Steve Lacy was to poets or how much he can now teach them by fact of his own practice and example. No one was ever more generous or perceptive."
In 1992, he was the recipient of a MacArthur Fellowship (nicknamed the "genius grant").