Serena, who is around 15 months younger than her sister, won in straight sets 6-4 6-4.
The American now also takes back the world number one ranking from German Angelique Kerber.
Venus and Serena have played each other many times over their long careers, but have always put sisterly love over any sporting rivalry.
After losing, Venus said, "Congratulations Serena on number 23."
"I have been right there with you, some of them I lost right there against you. It's been an awesome win."
"I'm enormously proud of you, you mean the world to me. I, God willing, would love to come back. Thank you for all the love."
Serena also paid tribute to her big sis, saying: "There's no way I would be at 23 without her. There's no way I'd be at one without her. She's my inspiration.
"She's the only reason I'm standing here today. She's the only reason the Williams sisters exist. Thank you for inspiring me. Every time you won this week, I felt like I got a win too."
The final was the 28th time the sisters have played each other, with Serena now 17-11 ahead and 7-2 up in Grand Slam finals.
Venus, who turned professional in 1994 and has won five Wimbledon and two US Open titles, insisted she was not too disappointed after losing the match which was her first major final since 2009.
"No, because I guess I've been here before, "she said. "I really enjoy seeing the name 'Williams' on the trophy. This is a beautiful thing."
Serena Williams has beaten her big sister Venus to win the Australian Open for a seventh time, giving her a record 23 Grand Slam singles titles.