DNA polymerases are enzymes responsible for the synthesis of DNA from nucleotides. Understanding their molecular fundamentals is a prerequisite for elucidating their aberrant activities in diseases such as cancer. Here we have carried out ab initio quantum mechanical/molecular mechanical (QM/MM) studies on the nucleotidyl-transfer reaction catalyzed by the lesion-bypass DNA polymerase IV (Dpo4) from Sulfolobus solfataricus, with template guanine and Watson-Crick paired dCTP as the nascent base pair. The results suggested a novel water-mediated and substrate-assisted (WMSA) mechanism: the initial proton transfer to the alpha-phosphate of the substrate via a bridging crystal water molecule is the rate-limiting step, the nucleotidyl-transfer step is associative with a metastable pentacovalent phosphorane intermediate, and the pyrophosphate leaving is facilitated by a highly coordinated proton relay mechanism through mediation of water which neutralizes the evolving negative charge. The conserved carboxylates, which retain their liganding to the two Mg2+ ions during the reaction process, are found to be essential in stabilizing transition states. This WMSA mechanism takes specific advantage of the unique structural features of this low-fidelity lesion-bypass Y-family polymerase, which has a more spacious and solvent-exposed active site than replicative and repair polymerases.