China claims Taiwan as part of its territory and has branded 64-year-old Lai a "dangerous separatist" who will bring "war and decline" to the island.
Lai succeeds President Tsai Ing-wen, whose eight years in power saw a sharp deterioration in relations with Beijing over her rejection of China's claim.
Like Tsai, Lai is a staunch defender of the island's democracy and in the past has described himself as a "pragmatic worker for Taiwan independence".
Lai has toned down his rhetoric and has repeatedly vowed to maintain the "status quo" on the Taiwan Strait, which means preserving Taiwan's sovereignty while not declaring formal independence.
The inauguration ceremony was held at the Japanese colonial-era Presidential Office Building in Taipei, where Lai and his vice president-elect Hsiao Bi-khim were sworn into office shortly after.
Lai and Hsiao -- arguably better known on the global stage due to her former role as Taiwan's top envoy to Washington -- are both part of the Democratic Progressive Party (DPP), which has championed Taiwan's sovereignty.
Lai will on Monday deliver his inaugural speech -- which will be scrutinised for clues on how he will handle Taipei's delicate relationship with Beijing -- in front of thousands of people outside the Presidential Office.
Eight heads of state and representatives of 51 international delegations were invited -- including from the United States, Japan and Canada -- in a show of support for the island's democracy.
More than a thousand performers showcasing traditional operas and dances will take part in a celebration that also includes an Air Force aerial formation to salute the new president.
- More defence spending -
With only 12 allies, Taipei lacks diplomatic recognition on the world stage.
But it has its own government, military and currency, and the majority of the 23 million population see themselves as having a distinct Taiwanese identity, separate from the Chinese.
Following in Tsai's footsteps, Lai is expected to boost defence spending and strengthen ties with democratic governments, especially Washington, Taiwan's key partner and weapons supplier.
Beijing has long threatened to use force to bring Taiwan under its control -- especially if the island declares independence -- with Xi upping the rhetoric of "unification" being "inevitable".
Ahead of Lai's inauguration, Beijing's Taiwan Affairs Office, which handles cross-strait issues, called "Taiwan independence and peace in the strait... like water and fire".
Chinese warplanes and naval vessels maintain a near-daily presence around the island.
Lai has made overtures for resuming high-level communications with China, which Beijing severed in 2016 when Tsai took power, but experts say they are likely to be rebuffed.
The DPP has lost its majority in Taipei's parliament -- where a brawl broke out Friday among lawmakers from all three parties -- which could make it difficult for Lai to push through his policies.
But many Taiwanese are less worried about the threat of conflict than they are about soaring housing prices, rising cost of living pressures, and stagnating wages.
"If war should break out there would be little I could do," Jay, a 20-year-old student who gave only his first name, told AFP as he took a photo of the Presidential Office.
"So I will just go with the flow."
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