Bhutan's early history is steeped in mythology and remains obscure. Some of the structures provide evidence that the region has been settled as early as 2000 BC. According to a legend it was ruled by a Cooch-Behar king, Sangaldip, around the 7th century BC, but not much is known prior to the introduction of Tibetan Buddhism in the 8th century, when turmoil in Tibet forced many monks to flee to Bhutan. In the 12th century, the Drukpa Kagyupa school was established and remains the dominant form of Buddhism in Bhutan today. The country's political history is intimately tied to its religious history and relations among the various monastic schools and monasteries.

Since at least the tenth century, no outside power has ever occupied or governed Bhutan (notwithstanding occasional nominal tributary status).

The consolidation of Bhutan occurred in 1616 when Ngawanag Namgyal, a lama from western Tibet known as the Zhabdrung Rinpoche, defeated three Tibetan invasions, subjugated rival religious schools, codified the Tsa Yig, an intricate and comprehensive system of law, and established himself as ruler over a system of ecclesiastical and civil administrators. After his death, infighting and civil war eroded the power of the Zhabdrung for the next 200 years. In 1885, Ugyen Wangchuck was able to consolidate power, and began cultivating closer ties with the British in the subcontinent.

On December 1907, Ugyen Wangchuck (Bhutan:འབྲུག་རྒྱལ་དང་པ་ཨོ་རྒྱན་དབང་ཕྱུག) was enthroned as the first hereditary king of Bhutan. In 1910, King Ugyen and the British signed the Treaty of Punakha which provided that British India would not interfere in the internal affairs of Bhutan if the country accepted external advice in its external relations. When Ugyen Wangchuck died in 1926, his son Jigme Wangchuck became the second king, and when India gained independence in 1947, the new Indian Government recognized Bhutan as an independent country. In 1949, India and Bhutan signed the Treaty of Peace and Friendship, which provided that India would not interfere in Bhutan's internal affairs, but would guide its foreign policy. Succeeded in 1952 by his son Jigme Dorji Wangchuck, Bhutan began to slowly emerge from its isolation and began a program of planned development. The National Assembly of Bhutan, the Royal Bhutanese Army, and the Royal Court of Justice were established, along with a new code of law. Bhutan became a member of the United Nations in 1971.

In 1972, Jigme Singye Wangchuck ascended the throne at age 16. He emphasized modern education, decentralization of governance, the development of hydroelectricity and tourism and improvements in rural developments. He was perhaps best known internationally for his overarching development philosophy of "gross national happiness." It recognizes that there are many dimensions to development and that economic goals alone are not sufficient. Satisfied with Bhutan's transitioning democratization process, he abdicated in December 2006 rather than wait until the promulgation of the new constitution in 2008. His son, Jigme Khesar Namgyel Wangchuck, became King upon his abdication.

A state of Lhomon (literally, southern darkness) or Monyul (dark land, a reference to the Monpa, one of the Tibeto-Burman peoples of Bhutan), possibly a part of Tibet that was then beyond the pale of Buddhist teachings. Monyul is thought to have existed between AD 100 and AD 600. The names Lhomon Tsendenjong (southern Mon sandalwood country) and Lhomon Khashi (southern Mon country of four approaches), found in ancient Bhutanese and Tibetan chronicles, may also have credence and have been used by some Bhutanese scholars when referring to their homeland. Variations of the Sanskrit words Bhota-ant (end of Bhot) or Bhu-uttan (meaning highlands) have been suggested by historians as origins of the name Bhutan, which came into common foreign use in the late 19th century and is used in Bhutan only in English-language official correspondence. The traditional name of the country since the 17th century has been Drukyul—country of the Drukpa, the Dragon people, or the Land of the Thunder Dragon, a reference to the country's dominant Buddhist sect.

Some scholars believe that during the early historical period the inhabitants were fierce mountain aborigines, the Monpa, who were of neither the Tibetan or Mongol stock that later overran northern Bhutan. The people of Monyul practiced a shamanistic religion, which emphasized worship of nature and the existence of good and evil spirits. During the latter part of this period, historical legends relate that the mighty king of Monyul invaded a southern region known as the Duars, subduing the regions of modern Assam, West Bengal, and Bihar in India.

Buddhism was possibly first introduced to Bhutan as early as the 2nd century AD. Tibetan Buddhism was first introduced to Bhutan in the 7th century. Tibetan king Songtsän Gampo (reigned 627–649), a Buddhist convert, constructed 108 Buddhist temples in the Himalayan region, including a few temples at Bumthang in central Bhutan, Haa, Lhuentse and at Kyichu (near Paro) in the Paro Valley. Buddhism was propagated in earnest in 746 under King Sindhu Rāja (also Künjom; Sendha Gyab; Jakar Gyalpo), an exiled Indian king who had established a government in Bumthang at Jakar Gutho Palace.