In this paper, effective damage tolerance of a functionally graded coating (FGC) deposited by high velocity oxygen fuel (HVOF) spraying is observed. The thick FGC (≈ 1.2 mm) consists of 6 layers with a stepwise change in composition from 100 vol% ductile AISI316 stainless steel (bottom layer) to 100 vol% hard WC-12Co (top layer) deposited onto an AISI316 stainless steel substrate. Damage tolerance is observed via 1) an increase in compliance with depth, and 2) an increase in fracture resistance by containment, arrest and deflection of cracks. A smooth gradation in the composition and hardness through the coating thickness is found by scanning electron microscopy and depth-sensing microindentation, respectively. The in-situ curvature measurement technique reveals that during the deposition of the FGC, compressive stresses exist in the lower, metallic layers owing to peening effect of successive impact, and these gradually evolve to high tensile, in the top layers. Tensile stresses appear to be due to quenching alone; thermal stresses are low because of the gradation. All of this is beneficial for the deposition of a thick coating. The FGC structure shows the ability to reduce cracking with increased compliance in the top layer during static and dynamic normal contact loading, while retaining excellent sliding wear resistance (ball-on-disk tests). Results are discussed in comparison to the behavior and properties of coatings of similar individual compositions and thicknesses, as well as a thick monolithic WC-12Co sprayed coating. Further improvements in the processing are proposed to enhance the adhesion strength and avoid coating delamination under high load contact-fatigue conditions.