Palace co-chairman Steve Parish announced the news at a hastily-arranged press conference, which came two days after the team lost 4-1 at home to Fulham.
The defeat left them second bottom of the Barclays Premier League, with seven losses from eight games.
Parish said: "Ian's contract at Crystal Palace has come to an end by mutual consent
"Ian felt that a new approach might help keep us in the division.
"I've enjoyed every minute of working with Ian. He leaves our club with his head held very high.
"I'd like to put the record straight. We've never fallen out. We've worked together brilliantly. We feel we need to move on to progress."
Holloway only took over at Selhurst Park last November and led them to promotion via the play-offs.
But this season only Sunderland's woeful form has kept them off the foot of the table and the thrashing at home by fellow strugglers Fulham was the final straw.
Holloway said: "I have pride in the job we've both done. It wasn't easy. If Steve's last manager (Dougie Freedman, who left for Bolton) wasn't headhunted I wouldn't have been here.
"We need to shut up shop in this division. At the minute we've got a whole new group there.
"Part of my talking with Steve was about am I the one with the energy left?
"I have to hold my hand up and say we didn't keep the spirit that got us up. We changed too much too quickly."