Twin tunnels will be built between Blackheath and Hartley, with the state government confirming it as the preferred option.
Deputy Premier, Paul Toole, said it would be the longest road tunnel in Australia and would be toll-free.
"The Great Western Highway upgrade will improve safety for the thousands of people living in and travelling through the Blue Mountains on the highway every day," Mr Toole said.
"This is a heavy traffic route to the Blue Mountains villages of Medlow Bath, Blackheath and Mount Victoria, and then onto the Central West, so it's important we take on community feedback to ensure we deliver an upgrade locals want and need."
A Transport for NSW report on the issue had concluded that "two identical (twin) tunnels, one eastbound and one westbound, around 11 kilometres long would deliver more benefits for the environment, the community and road users than two shorter tunnels beneath the villages of Blackheath and Mount Victoria".
The tunnels will run generally to the south of the existing highway at depths ranging from 20 metres near the portals to almost 200 metres at the deepest part south of Mt Victoria.
The eastern portal will be around 400 metres south of Evans Lookout Road in Blackheath. The western portal will be at the bottom of Victoria Pass.
The TfNSW report noted it was investigating the best ways to protect groundwater and the Mountains' hanging swamps. Other issues include disposal of excavated soil, minimising impacts in the Hartley Valley and ventilation issues.
Michael Paag from the Blackheath Alliance said it was "great news".
"It will provide a total bypass, protecting these iconic Mountains villages. It also finally means we don't have to rely on a convict built bridge and 1950s infrastructure for the main highway west of Blackheath."
But Blue Mountains MP, Trish Doyle, said she was concerned about financing for the project and opening the door for huge trucks travelling through the Mid and Lower Mountains.
"The Nationals have re-announced a line on a map but failed to attach adequate funding to dig a single metre of tunnel under Blackheath. It remains a fantasy tunnel that they are trying to wed future governments to, while refusing to explain who will foot the bill," she said.
"The Great Western Highway should not be viewed just as a motorway for trucks to and from Bathurst. It's a local road for residents of the Blue Mountains, and this proposal opens the door to thousands of 23-26m long B-Double trucks to traverse the lower and middle sections of the highway between Katoomba and Glenbrook. While these trucks are presently prohibited through the Lower and Mid Mountains due to the tight bends near Mount Victoria, the Nationals tunnel plan for the Upper Mountains is all about getting larger and longer trucks to drive throughout the entire width of the Blue Mountains."
TfNSW will hold online and face-to-face sessions to answer questions on the project. Online sessions will be on Monday, May 23, 6.30-8pm and Thursday, June 9, 6.30-8pm. Face-to-face sessions on May 18, 6-8pm at Hartley Hall; May 25, 6-8pm at Katoomba Cultural Centre; and June 4, 10am-noon, Blackheath Neighbourhood Centre. Register for a consultation session at nswroads.work/gwhtunnel.
TfNSW will now prepare an environmental impact statement and concept design. Both are expected to be put on public exhibition in the second half of this year.
