Keys appeared to have one foot in the last eight when she went to serve for the match at 5-2 up the deciding set but clutched her left groin immediately after getting broken.
The American 12th seed called for the trainer one game later and limped off court for a medical time out before re-emerging with her left thigh heavily strapped.
Upon resumption, she started sobbing after netting a drop shot to fall 15-40 behind. Although Keys saved the first break point with a stupendous backhand winner, she was again in tears after surrendering her serve with a double fault.
Clearly struggling to even walk between points, Keys somehow conjured a lob to win the first point off Paolini's next service game. But when she saw the next point whizz past her for an ace, she shook her head and signalled it was all over as she walked to the net to give her Italian opponent a tearful hug.
The Italian seventh seed had produced a stirring comeback from 5-1 down in the second set to force a tiebreak and the final score ended up being 6-3, 6-7(6), 5-5 in Paolini's favour when a heartbroken Keys had to call it a day.
Paolini will next face either US Open champion Coco Gauff or American 19th seed Emma Navarro.
"I'm so sorry for her. To end the match like this it's sad. We played a really good match. it was really tough, lots of up and downs. I feel a bit happy but also sad for her because it's not easy to win like that," Paolini, who had not won a Tour-level main draw match on grass before this year, told the crowd in a courtside interview.
"It was a rollercoaster. I started really well and was really focused on court but she's a great champion and she raised her level so it was tough to return balls. I was repeating to myself stay in there. At the end I know she retired, but I'm here with the win.
"I hope you enjoyed the match," she added after becoming the fifth Italian woman to reach the Wimbledon quarter-finals in the professional era, equalling the country's best result at the grasscourt major.
