The eight-year veteran was dealt to the Broncos from Detroit just before the March 1 free-agent signing deadline, in exchange for running back Tatum Bell, right tackle George Foster and a draft pick.
Originally, he balked at joining the Broncos.
Terms on the extension were not disclosed, but the Denver Post has reported that it is for five years and $33 million.
"I'm happy we got (the deal) done," Broncos owner Pat Bowlen told the newspaper from the site of the NFL Winter Meetings in Phoenix.
Bly -- who was a second round draft pick by the St. Louis Rams out of North Carolina in 1999 -- has 33 interceptions, 323 tackles and three sacks in 119 NFL games.
Last season with the Lions, he had three interceptions and 58 tackles (50 solo) in 16 games.
He has never missed any appreciable time because of injury.