The UK law banning "gross indecency" will now have to be changed, prompting celebrations among gay rights campaigners.
The homosexual man from Yorkshire was convicted of taking part in gay group sex at his home.
The man, known only by his initials, ADT, was prosecuted after police found a video of men taking part in sex acts at his home.
He appealed to the European Court of Human Rights, claiming that gross indecency is a discriminatory law because it applies only to men.
Sex between men is legal in Britain if it is in private between two consenting partners who are 18 or over. If more people are involved or if the sex is in public, it is illegal.
'Historic victory'
The judges decided the conviction was a violation of the man's "right to respect for a private family life".
He was conditionally discharged for two years in November 1996, and was awarded £20,929 damages with £12,391 costs.
The Sexual Offences Act will have to be changed to bring the UK into line with the rest of Europe.
Peter Tatchell of gay rights group Outrage! described the ruling as an "historic victory".
Call for law repeal
Mr Tatchell said: "This ruling spells the end of the gross indecency law which was used to convict Oscar Wilde in 1895.
"It's astonishing that it survived so long, but this decision means the government will have to repeal it.
"It is another historic victory on the road to gay equality. It makes the remaining areas of discrimination in sexual offences law unsustainable.
"But it's a great shame that legal change has to be imposed via the European Court rather than the free will of a parliament that respects the rights of its gay citizens."
Lesbian and gay rights group Stonewall said the ruling "drives a coach and horses" through Britain's gross indecency laws.
Executive director Angela Mason, said: "It vindicates the view of the Sexual Offences Review that this legislation violates the right to privacy set out in the European Convention of Human Rights.
"I believe the government will now have to issue a directive to police officers telling them not to continue prosecutions under this offence."
'Harming family life'
Dr Adrian Rogers, adviser to pro-family pressure group Family Focus, said the ruling highlighted the need for Britain to distance itself from Europe, which is "bringing down the social fabric of our society".
He said: "They are giving a status to a form of activity which is less than desirable, medically hazardous and which really stands in opposition to the alternative, which is heterosexual family life.
"One wonders whether anything is going to remain illegal in Europe."
A Home Office spokeswoman said the judgment would be taken into account in formulating sexual offences law in the future.
"We will be studying the judgment carefully," she said."