Pegula defeated the title-holder and her fellow American Keys 6-3, 6-4 at a hot and sunny Melbourne Park.
Keys, who stunned world number one Aryna Sabalenka in last year's final, made 27 unforced errors to Pegula's 17 and fired down six double faults.
"Obviously not the way that I wanted things to end here, but still really proud of myself," said the 30-year-old Keys.
"I think coming back, being defending champion, dealing with all of the kind of extra pressure and nerves, I'm just really proud of myself for how I handled it.
"Just one of those days where I feel like Jess beat me, and I can kind of walk away with my head held high."
Keys and Pegula are friends off court and also host a tennis podcast together.
Keys hopes her team-mate can go on and win the tournament.
She conceded that Pegula, who is chasing an elusive Grand Slam title, had been in charge almost from the start and dictated play.
"It's not like the world is ending because I lost today," added Keys, who failed to win another tournament after triumphing in Melbourne 12 months ago."
"I have 11 months of the year left and there is still lots to be proud of," she said.
"And I'm still going to go out and work on new things and try to implement them in the next tournament."
Sixth-seeded Pegula will face American fourth seed Amanda Anisimova after her 7(7)-6(4), 6-4 win over China's Wang Xinyu.
