The divergence of archaea, bacteria and eukaryotes was a fundamental step in evolution. One marker of this event is a major difference in membrane lipid chemistry between these kingdoms. Whereas the membranes of bacteria and eukaryotes primarily consist of straight fatty acids ester-bonded to glycerol-3-phosphate, archaeal phospholipids consist of isoprenoid chains ether-bonded to glycerol-1-phosphate. Notably, the mechanisms underlying the biosynthesis of these lipids remain elusive. Here, we report the structure of the CDP-archaeol synthase (CarS) of Aeropyrum pernix (ApCarS) in the CTP- and Mg2+-bound state at a resolution of 2.4 Å. The enzyme comprises a transmembrane domain with five helices and cytoplasmic loops that together form a large charged cavity providing a binding site for CTP. Identification of the binding location of CTP and Mg2+ enabled modeling of the specific lipophilic substrate-binding site, which was supported by site-directed mutagenesis, substrate-binding affinity analyses, and enzyme assays. We propose that archaeol binds within two hydrophobic membrane-embedded grooves formed by the flexible transmembrane helix 5 (TM5), together with TM1 and TM4. Collectively, structural comparisons and analyses, combined with functional studies, not only elucidated the mechanism governing the biosynthesis of phospholipids with ether-bonded isoprenoid chains by CTP transferase, but also provided insights into the evolution of this enzyme superfamily from archaea to bacteria and eukaryotes.