The Russian stock market, sensitive to politically charged issues, dove within minutes of the verdict, with the main MICEX index dropping 1.4 per cent before partly recovering.
The conviction galvanized the opposition, which has been increasingly cornered by the Kremlin's crackdown and weakened by internal rifts. A few hours after the verdict, several thousand activists gathered on a central avenue a few hundred metres from Red Square, clapping their hands and chanting "Freedom!" and "Putin is a thief!"
They briefly blocked traffic on busy Tverskaya avenue, shouting "This city is ours!" Police rounded up several dozen demonstrators, but didn't move to disperse the rally that went on for several hours.
The protesters stuck posters to advertising billboards that read: "Putin, you coward, come out!" and "Navalny isn't guilty! Navalny to president, Putin to prison!"
Activists handed out bright red stickers reading "Navalny, change Russia! Start with Moscow" as many passing motorists blared horns in support.
The unsanctioned protest looked small compared to the massive anti-Putin demonstrations which attracted more than 100,000 in the fall of 2011 and the beginning of the following year. But unlike those protests, which were allowed by the authorities, the participants in Thursday's rally braved the threat of heavy fines and prison sentences.
Several hundred demonstrators also rallied in Navalny's support in St.Petersburg and a few dozen were detained by police.
Navalny was found guilty of heading a group that embezzled 16 million rubles ($500,000) worth of timber from a state-owned company in 2009.
The blue-eyed 37-year-old played with his smartphone for much of the nearly 3 1/2-hour verdict reading. A post on his Twitter account after the sentence was announced told his supporters: "Oh, well. Don't get bored without me. And, importantly, don't be idle."
Navalny handed his phone and watch to his wife, Yulia, before bailiffs took custody of him and a co-defendant Pyotr Ofitserov, who was given a four-year sentence.
Navalny's mayoral campaign chief, Leonid Volkov, said he would stay in the race if set free. "It's quite simple: if he is released he will; if not, he won't."
The US and EU both criticized the ruling within hours, arguing that the case appeared to be politically motivated.
Former Soviet President Mikhail Gorbachev joined the protests, saying in a statement that the conviction demonstrated that "our courts aren't independent".
"It's inadmissible to use courts against political opponents," Gorbachev said.
Navalny began his rise to prominence by blogging about his investigations into corruption at state-owned companies where he owned shares, reaching hundreds of thousands. Navalny and his team of lawyers and activists have plumbed property registers abroad to identify top officials and lawmakers who own undeclared foreign assets and hold foreign citizenship.
Navalny's blog quickly became an Internet sensation not only because of his exposures but because it was very user-friendly, with lots of illustrations, funny images and witty catchphrases.
It was Navalny who first called the dominant United Russia party "the party of crooks and thieves," a phrase that has dogged Kremlin loyalists ever since.
Navalny's investigations targeted a wide circle of loyalists to President Vladimir Putin - from members of parliament to state bankers, threatening to discredit the system of governance he has built.
Navalny meticulously listed all the promises Putin made each of his year in power about upgrading Russia's crumbling housing. He named Putin "Obeshchalkin" or Mr. Promise-sky for failing to keep these promises.
When the evidence of massive fraud in the 2011 parliamentary elections triggered protests, Navalny quickly became a driving force thanks to a combination of energy, quick wits and talent of a public speaker.
His chant "We are the power!" has become a battle cry for the protesters. At one of the protests, he energized the demonstrators that the crowd was big enough to take the Kremlin. He launched biting harangues at Putin and his lieutenants, once likening them to jackals huddling to each other in fear.
Clearly shaken by the big rallies, Putin tried to dismiss Moscow protesters as representatives of the spoiled elite at odds with the needs of blue-collar workers, his main support base. He struck back at his foes after his victory, and the relentless Kremlin crackdown culminated in Navalny's trial.
After hearing the judge pronounce him guilty, Navalny looked distressed but soon became his usual cheerful self, exchanging reassuring glances with his wife and parents as the judge read the sentence. Navalny cracked jokes and his observations of the hearing on Twitter, and asked his followers to send him funny things to "cheer everyone one up".
When the judge announced the prison sentence, the wife of Navalny's co-defendant, Pyotr Ofitserov, collapsed on the floor. Navalny's wife looked shaken but kept her composure.
"If someone hopes that Alexei's investigations will cease, that's wrong," she told reporters outside the court.
The charges against Navalny date back a few years when he worked as an unpaid adviser to the provincial governor in Kirov, about 760 kilometres east of Moscow. Prosecutors say he was part of a group that embezzled 16 million rubles' ($500,000) worth of timber from state-owned company Kirovles.
The defence said Ofitserov's company bought the timber from Kirovles for 14 million rubles and sold it for 16 million rubles in a regular commercial deal. Navalny's lawyers presented invoices proving the transactions.
None of the managers at Kirovles who appeared in court, except for former Kirovles director, Vyacheslav Opalev, testified that Navalny defrauded the company.
Navalny insists Opalev framed him out of revenge: Navalny had recommended that Opalev be fired and that officials investigate potential corruption in his company.
Opalev got a suspended sentence in an expedited trial in December after pleading guilty to conspiring with Navalny.
Navalny had long said he expected to be convicted, and in a final blog post before leaving Moscow for Kirov, he downplayed his personal importance.
"The most important thing is to muster up the strength, shake off laziness and do something. This doesn't require any leadership as such," he wrote.
At the White House, spokesman Jay Carney said the Obama administration was "deeply disappointed and concerned" by the conviction, calling the verdict the latest example of a "disturbing trend of government action" to suppress civil society in Russia.
Sen. Robert Menendez, chairman of the Senate Foreign Relations Committee, said that "Russia is returning to its old authoritarian ways where opposition voices were silenced and trumped up charges ended in unfair verdicts".
Catherine Ashton, the European Union's foreign policy chief, said the verdict and sentence, "given the procedural shortcomings, raises serious questions as to the state of the rule of law in Russia".
- AP
