Raonic came agonisingly close to a golden summer on grass last year when he reached the Queen's and Wimbledon finals, only to lose to Andy Murray on both occasions.
But the Canadian's hopes of warming up for Wimbledon with another strong showing at Queen's were wrecked by Kokkinakis's stunning 7-6 (7/5), 7-6 (10/8) triumph.
Raonic wasn't the only leading seed embarrassed on a baking hot afternoon in west London as world number three Stan Wawrinka was beaten 7-6 (7/4) 7-5 by Spain's Feliciano Lopez in the Swiss star's first match since being thrashed by Rafael Nadal in the French Open final.
Kokkinakis needed a wild card from the tournament organisers to make the Queen's main draw after his ranking plunged to 698 following an abdominal strain that sidelined him for 18 weeks.
Finally fit again, the 21-year-old secured his first Tour level match win for 21 months at 's-Hertogenbosch last week, but even so he surely wouldn't have expected to clinch the best win of his promising career just days later.
"You don't want to know about the extensive list of injures I've had. That was 22 months out of the game," Kokkinakis said.
"I can't wait to play in the next round."
Kokkinakis faces Nicolas Mahut or Daniil Medvedev in the last 16.
Raonic only reached the last 16 at the recent French Open, but clay doesn't suit his big-serving game as well as the manicured lawns of London.
Having recently hired former Grand Slam doubles champion Mark Knowles as his coach, Raonic was looking to make a statement of intent at Queen's.
Instead, it was Kokkinakis who announced his own credentials as a future grass-court force in memorable fashion.
"I was just a little too passive. I was letting him dictate too much," Raonic said.
"Obviously the disappointment is high right now, but whatever the result was this week, I don't think that's really going to change my chances at Wimbledon."
Back on court for the first time since his straight-sets defeat against Nadal in Paris, second seed Wawrinka was hoping to erase that painful memory with a rare good run at Queen's.
But the 32-year-old had lost four of his eight previous Queen's matches and once again he was destined for disappointment.
Lopez is only ranked 32nd but the canny left-hander reached the Queen's final three years ago and he out-smarted Wawrinka with a grass-court masterclass that left the three-time Grand Slam champion unable to respond.
"I knew it was going to be tough against Stan so this was a great win for me," said Lopez, 35, who made the Stuttgart final on grass last week.
"I'm one of the oldest guys on the tour, but I feel healthy. I know and read the game better than 10 years ago."