The derelict vessel, which is currently located at Alexandra Dock in Belfast, was in danger of rusting away.
A light cruiser, weighing 3,750 tons and measuring 446 feet, HMS Caroline was part of the screening force that sailed out ahead of the Royal Navy's Grand Fleet during the Battle of Jutland to establish the position of the German battleships.
Both sides sustained heavy casualties in what was the most significant clash between battleships during WWI, with Britain and Germany both claiming victory.
Six years after the war ended, HMS Caroline was moved from Portsmouth to Belfast to become a training vessel for local Royal Navy Reserves.
Most of the rest of the fleet was decommissioned and broken up.
During World War Two, the vessel was used as an operations headquarters for the efforts to protect the Atlantic convoys from German U-Boats.
The HMS Caroline performed its function as a drill ship up until 2011.
The National Museum of the Royal Navy are now confident the ship will be opened as a "world class" visitor attraction ahead of the centenary of its most famous wartime engagement - the 1916 Battle of Jutland off the coast of Denmark.
The Heritage Lottery Fund gave initial approval to a £12.2m funding application to finance the restoration on Thursday - the largest ever commitment made by the fund in Northern Ireland.
It has pledged £845,600 in first stage development funding and, if that work is completed as envisaged, the remainder of the money will then be released.
The museum would complement a variety of maritime attractions in Belfast's old shipyards, including the Titanic Belfast visitor attraction.
Captain John Rees, chief of staff at the National Museum of the Royal Navy (NMRN), said the significance of the ship could not be overstated.
"She is a one of a kind, an iconic ship," he said.
"The only floating survivor of all the fleets - both German and British - that fought in the First World War and the Battle of Jutland."
Captain Rees said he was confident the museum would be open ahead of the 100th anniversary in May 2016.
"The National Museum has a view, along with the (Stormont's) Department of Enterprise, Trade and Investment, that there is the opportunity here to create a world class visitor attraction for Belfast and for Northern Ireland with a number of hugely interesting and important naval and maritime attractions.
"Not only that, it's an opportunity I think to involve all of the community of Northern Ireland in something that is uniquely Belfast and Northern Ireland.
"It's been here for the majority of its life - 80 plus years. It is something that all the community can share in and enjoy - it's something very special for them."
Last year, a £1m grant from the National Heritage Memorial Fund was secured for urgent repairs.
That was seen as the first stage in a two part rescue mission - the second element being the lottery application.
Paul Mullan, head of HLF Northern Ireland, said the funding reflected the importance of the ship.
"It's very timely. We are now in the decade of anniversaries and the First World War is one of those key anniversaries. We've 1916 with the (Battle of the) Somme, the 1916 Easter Rising (in Dublin).
"The Battle of Jutland is another particular story which is of tremendous importance," he added.
"We see it very much in that context of a number of anniversaries that are going on and this is a great way of showing Belfast's link into the First World War."
Northern Ireland Tourism Minister Arlene Foster welcomed the funding boost.
"Over the last year, there has been a significant effort, from myself and others to find a solution to keeping HMS Caroline here," she said.
"We have developed a strong partnership with the National Museum of the Royal Navy. This partnership will continue as we restore the ship.
"HMS Caroline has become part of the city's rich maritime heritage."