The canal's construction was initiated by Union forces during the American Civil War to bypass a meander loop of the river around a peninsula known as Farrar's Island that was controlled by Confederate artillery.

[4] The name is attributed to a palisaded fosse that Dale is thought to have built across the neck to protect the town from attack on the north side of the river.

During the American Civil War in late August, 1864, General Benjamin Butler, commander of the Union Army of the James, ordered the construction of a canal at Dutch Gap.

[12] Of particular threat was Battery Dantzler at the northern end of the Howlett Line where Confederate forces had installed two seven-inch Brooke rifles, two ten-inch Columbiad guns, and two siege mortars[13] that had a half mile field of fire on the James River that lay on the east side of Farrar's Island.

[11] Another purpose was to continue military activity as part of the larger Petersburg Campaign to ensure that Confederate manpower resources remained strained in Eastern Virginia and unable to redeploy to other sectors.

[20]: 390  In general, the Union army often treated the men of USCT units as second-class citizens relegating them primarily to fatigue duty,[19] and this was also a concern during the building of the Dutch Gap Canal.

[11] This additional need often led to inequities in the treatment of men USCT units, who were frequently assigned more fatigue duties than white soldiers.

[22] Due to their protest, the freedmen did eventually get paid; however, their compensation as civilian laborers was small and less regular than men doing similar work in the USCT units[23] The Dutch Gap Canal also became a focal point for negotiating the treatment of black soldiers captured by the Confederates during the Petersburg Campaign.

[33] The challenges with improving the canal and the rest of the James River to accommodate larger ships may have played a role in hindering Richmond's post-Civil War development as an inland port.

[35] Currently, the canal's commercial traffic consists of primarily of container barges and feeder ships transporting goods between Hampton Roads and Richmond.

[42] An electricity-generating facility owned by Dominion Energy is located nearby on the south shore of the James River near an extension of the canal, the Dutch Gap Cutoff, that created Hatcher Island out of another, wider bend.