Earlier this week, Downes was banned from all football activity for 28 days and fined by the Football Association after admitting breaking betting rules.
The 58-year-old admitted placing five bets on matches between November 30, 2013 and January 30, 2014, and three bets between March 16, 2019 and July 12, 2019.
After 10 months at the helm, Downes leaves the Sky Bet League One club by mutual consent with Glyn Hodges - who was placed in temporary control on Friday - to continue as caretaker manager.
A statement on the Wimbledon website read: "AFC Wimbledon has today reached an agreement to part company with first-team manager Wally Downes.
"Wally leaves on mutually agreed terms and with our sincerest gratitude for his time with the club, especially his invaluable contribution last season. The agreement was reached with the approval of the Dons Trust board.
"The club and Dons Trust boards suspended Wally last month when the FA announced it had charged him with alleged betting contraventions, with assistant manager Glyn Hodges placed in temporary control of first-team affairs.
"While Wally's FA disciplinary process concluded last week, the boards believe that a change of first-team manager is the best option to help the club maintain its recent upturn in performances.
"Naturally, Wally leaves with our sincerest best wishes for the future and his place in our club's history - as both a player and manager - assured."
Downes had already missed five matches after being suspended by the club since first being charged on September 25.
In Downes' absence - and after an 11-match winless run from the start of the season - assistant Hodges has picked up three wins in three League One games as well as an EFL Trophy victory over Leyton Orient.
The statement continued: "In particular, Wally's legacy can be found in the young vibrant squad we see on the pitch today, his attention to the financial constraints of the club and ensuring we maintained financial sustainability and laying the foundations for a squad capable of achieving a healthier league position.
"Under the terms of the agreement reached with Wally, we will be making no further public statement about either his departure or the betting charges.
"We are pleased that Glyn Hodges will continue as caretaker manager."
Downes has been in charge of the Dons since December 2018 and guided the club to safety on the final day of last season after they picked up 21 points from their final 12 matches.
Downes spent almost a decade playing for Wimbledon between 1979 and 1988, and is often referred to as the 'founder' of the Crazy Gang.
