The Italian came home strongly to win by a fingertip in 59.03secs, with Peaty and American Nic Fink both clocking 59.05 to share second place.
Chinese world champion Qin Haiyang led at the turn but faded to seventh.
The shock win shattered Peaty's hopes of matching American legend Michael Phelps as the only men to win three consecutive Olympic titles in the same event.
"It's been a very long way back," said Peaty.
"It doesn't matter what the time is, to me I've already won. It took so much to get here. I know in my heart I could have done more."
The race was billed as a showdown between Peaty and Qin, the 200m world record holder.
When Peaty took time out to address mental health issues, Qin swept all the breaststroke gold medals at last year's world championships.
But he came to Paris under a cloud, reportedly among the 23 Chinese swimmers who tested positive for a banned drug ahead of the Tokyo Games in a scandal that rocked the sport this year when it came to light.
Instead, Martinenghi stole their glory, adding to the bronze medal he won in Tokyo.
