Bailey, 23, joins the Reds after three years in the capital, the last few months of which were spent on loan at Reading FC Women.
Her footballing journey began at the Arsenal centre of excellence where she broke into the first team in 2013, going on to win two FA Cups and two Continental Cups.
The 2016 switch to Chelsea Women saw her make 16 appearances in her debut season before serious injury intervened.
She returned last season before joining Reading on loan in January.
Bailey will wear the No.8 shirt for LFC Women.
Reds’ manager Vicky Jepson said: "We wanted a young, talented individual to add quality and depth to our midfield.