A typically crucial Divock Origi volley deep into stoppage time levelled the tie at 5-5 as the Reds twice came from two goals down to send the match to spot-kicks.
Young goalkeeper Caoimhin Kelleher denied Dani Ceballos with the only save of the shootout, and Academy graduate Curtis Jones fired home the winning penalty to give the Reds a 5-4 win.
Here are five talking points from an action-packed night at Anfield...
Jones dazzles in spotlight
On as a 55th-minute substitute with his team 4-2 down, teenage Scouser Jones finished the match as one of Liverpool's triumphant heroes having made a major impact on the tie.
The Toxteth-born U23s captain set up Origi to make it 4-4 just seven minutes after coming on and then stepped up to slot home the winning penalty in front of the Kop on his senior home debut.
But his fairy-tale finale wasn't always in the script. Jürgen Klopp later revealed the 18-year-old was initially down to take the fourth penalty in the shootout.
"Divock was on number five, he was on number four," a smiling Liverpool boss said after the match.
"Then I saw Divock walking to take number four and I thought 'oh, OK, they’ve changed!' A good situation. You need to be born in Liverpool, probably, to do that!"
Cometh the hour...
Origi generally shuns standard fare in favour of the spectacular and vital - and on Wednesday night he scored two sensational and significant strikes against the Gunners.
The Belgian's name will be forever etched into LFC folklore for his incredible Champions League semi-final brace and final strike to help Liverpool become European champions last season - and his legend continues to be written this term.
Against Arsenal, Origi pirouetted and fired a pinpoint finish home from the edge of the box to make it 4-4, and then executed an athletic scissor-kick to secure a last-gasp 5-5 draw in front of the Kop.
The No.27, who also scored in the subsequent shootout, boasts an incredible recent goalscoring record for the Reds.
Including his dramatic 86th-minute winner against Newcastle United in May, Origi has netted seven goals from 13 attempts in 16 appearances at a remarkable shot conversion rate of 54 per cent.
The future is in safe hands
One of five starting Liverpool players making their home debut, 'keeper Kelleher certainly had a night to remember under the Anfield floodlights.
Instructed to “try to be the hero” by his teammates heading into the penalty shootout, the 20-year-old Irishman did just that.
Kelleher's full-stretch save to deny Ceballos put the only 'X' in the shootout scorecard as Liverpool booked their place in the quarter-finals.
"As soon as the final whistle went, all the focus was on trying to save in the shootout," Kelleher said.
"Some of the lads and the coaches said to me: ‘You’ve nothing to lose, just try to be the hero.’ And luckily I did it in the end."
Anfield young gun
At 16 years and 209 days old, Harvey Elliott became the youngest player ever to appear for the club at Anfield - but the teenager certainly wasn't overawed by the landmark occasion.
Elliott gave the home fans a taste of the touch and vision he displays regularly for the U23s and U19s, and his pace and trickery won the penalty which James Milner dispatched just before half-time.
However, his mental fortitude and natural rapport with the home fans were equally impressive, according to his manager.
"He is exceptionally talented, absolutely, and he’s a nice kid as well," Klopp said.
"To see him how he encouraged the crowd at the corners. I had a couple of moments when I was really touched tonight, to be honest. That’s really cool."
Goals, goals, goals
Wednesday's 10-goal thriller means Liverpool versus Arsenal is now the highest scoring fixture in the history of the League Cup, with 47 strikes recorded in their 15 meetings.
In fact, the last team to score five times at Anfield was also Arsenal and also in the League Cup - although the Gunners ran out 6-3 winners in that tie back in January 2007.