The evolution of parasitism is a recurrent event in the history of life and a core problem in evolutionary biology. Trypanosomatids are important parasites and include the human pathogens Trypanosoma brucei, Trypanosoma cruzi, and Leishmania spp., which in humans cause African trypanosomiasis, Chagas disease, and leishmaniasis, respectively. Genome comparison between trypanosomatids reveals that these parasites have evolved specialized cell-surface protein families, overlaid on a well-conserved cell template. Understanding how these features evolved and which ones are specifically associated with parasitism requires comparison with related non-parasites. We have produced genome sequences for Bodo saltans, the closest known non-parasitic relative of trypanosomatids, and a second bodonid, Trypanoplasma borreli. Here we show how genomic reduction and innovation contributed to the character of trypanosomatid genomes. We show that gene loss has "streamlined" trypanosomatid genomes, particularly with respect to macromolecular degradation and ion transport, but consistent with a widespread loss of functional redundancy, while adaptive radiations of gene families involved in membrane function provide the principal innovations in trypanosomatid evolution. Gene gain and loss continued during trypanosomatid diversification, resulting in the asymmetric assortment of ancestral characters such as peptidases between Trypanosoma and Leishmania, genomic differences that were subsequently amplified by lineage-specific innovations after divergence. Finally, we show how species-specific, cell-surface gene families (DGF-1 and PSA) with no apparent structural similarity are independent derivations of a common ancestral form, which we call "bodonin." This new evidence defines the parasitic innovations of trypanosomatid genomes, revealing how a free-living phagotroph became adapted to exploiting hostile host environments.