The veteran wicketkeeper, who has been facing a race against time to be fit for the first Ashes Test on December 8, was named in a News Corp report as being at the centre of a sexting scandal.
Paine, 36, fronted media in Hobart on Friday to announce he was resigning the captaincy but wanted to remain a member of the Test squad.
“It’s an incredibly difficult decision, but the right one for me, my family, and cricket,” he said.
“As a background on my decision, nearly four years ago, I was involved in a text exchange with a then-colleague.
“At the time, the exchange was the subject of a thorough CA integrity unit investigation, throughout which I fully participated in and openly participated in.
“Although exonerated, I deeply regretted this incident at the time, and still do today.
“I spoke to my wife and family at the time and am enormously grateful for their forgiveness and support.
“We thought this incident was behind us and that I could focus entirely on the team, as I have done for the last three or four years.
“However, I recently became aware that this private text exchange was going to become public.”
The messages date back to 2017, months before Paine was recalled to the Test team after a seven-year absence.
Paine was elevated to the captaincy in March 2018 following the explosive fallout from the ball-tampering scandal in South Africa.
Fast bowler Pat Cummins is Australia’s current vice-captain and had been tipped to assume the role once Paine retired.
“Tim felt it was in the best interests of his family and Australian cricket to take this decision to step down as captain,” CA chair Richard Freudenstein said.
“The board has accepted Tim’s resignation and will now work through a process with the national selection panel of identifying and appointing a new captain.
“While the board acknowledges an investigation cleared Tim of any breach of the code of conduct regarding this matter some years ago, we respect his decision.
“CA does not condone this type of language or behaviour.
“Despite the mistake he made, Tim has been an exceptional leader since his appointment and the board thanks him for his distinguished service.”
Cricket Tasmania released a statement claiming the allegations raised against Paine were only raised when the female employee was charged with theft.
CT chairman Andrew Gaggin said no complaint was made until mid-2018 following the message exchanges in November 2017.
“As soon as Cricket Tasmania was made aware, it undertook an investigation that determined the interaction was consensual, private, occurred on the one occasion only, was between mature adults and was not repeated,” Gaggin said.
Paine has played 35 Tests for Australia, taking 150 catches behind the stumps and has a batting average of 32.63.
South Australian Alex Carey is tipped to be Australia’s next Test wicketkeeper.