Cleavage of membrane proteins in the lipid bilayer by intramembrane proteases is crucial for health and disease. Although different lipid environments can potently modulate their activity, how this is linked to their structural dynamics is unclear. Here, we show that the carboxy-peptidase-like activity of the archaeal intramembrane protease PSH, a homolog of the Alzheimer’s disease-associated presenilin/γ-secretase is impaired in micelles and promoted in a lipid bilayer. Comparative molecular dynamics simulations revealed that important elements for substrate binding such as transmembrane domain 6a of PSH are more labile in micelles and stabilized in the lipid bilayer. Moreover, consistent with an enhanced interaction of PSH with a transition-state analog inhibitor, the bilayer promoted the formation of the enzyme’s catalytic active site geometry. Our data indicate that the lipid environment of an intramembrane protease plays a critical role in structural stabilization and active site arrangement of the enzyme-substrate complex thereby promoting intramembrane proteolysis.