Unseeded American Amanda Anisimova saved two match points to stun the former world number one 4-6, 6-3, 7-6 (10/5) in third round match.
Britain's Andy Murray, ranked 113 and playing as a tournament wild card, didn't stick around afterwards and walked quickly from the court, showing great disappointment at his lost opportunity.
Osaka, winner of the 2019 and 2021 Australian Opens, has vowed to have more fun on court this year, following a difficult last year in which she said she had suffered from depression.
With the men's world number one Novak Djokovic flying home after being denied entry to defend his title, the tournament remains wide open with Rafael Nadal, Alexander Zverev, Daniil Medvedev and Stefanos Tsitsipas all in contention.
Serbian President Aleksandar Vucic has said authorities in Australia "humiliated themselves" and Prime Minister Ana Brnabic called the decision to deport tennis player Novak Djokovic "scandalous."
The hearing will decide whether the Australian Open's top seed and defending champion can retain his title and become the first male player in history to win 21 Grand Slams.
The tennis star has been placed under guard ahead of a federal court hearing regarding his possible deportation.
The tennis star's visa was cancelled over community health risk concerns, with the tournament set to begin on Monday.
World number four's criticism comes as Novak Djokovic was included in the Australian Open official draw, although it is still uncertain whether the Aussie government will cancel Djokovic's visa for a second time over breaking Covid protocols.
World number one has been drawn for his first-round match while Australia's immigration minister still considers whether to deport Djokovic over his Covid-19 vaccine exemption.
Tennis world number one's fight to overturn the shock cancellation of his visa and his ensuing detention in a notorious Melbourne immigration facility will culminate in a highly publicised online hearing.
Novak Djokovic's lawyers have filed court papers in his challenge against deportation from Australia that show the tennis star tested positive for Covid-19 last month and recovered.
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