A two-step severe shot peening (SSP) method was designed to investigate the softening mechanism of nanostructured Mg-8Gd-3Y (GW83) alloys and its effects on the surface characteristics of the deformation layer. The experimental results indicated that a gradient deformation layer with nanocrystalline (50–100 nm) near the surface layer was fabricated by single SSP (0.54 mmN). The corresponding formation mechanism of nanocrystalline was mainly owing to continuous dynamic recrystallization (cDRX). By applying the two-step SSP (0.54 + 0.23 mmN) treatment, softening occurred near the surface layer (<50 μm) due to the occurrence of partial discontinuous dynamic recrystallization (dDRX). The reason for dDRX behavior during SSP treatment resulted from the combined effects of high-level stored strain energy and heat production. This softening behavior was characterized by the increase of domain size, the slight enhancement of basal texture, and the decrease of dislocation density and microhardness. Therefore, appropriate SP parameters should be selected to avoid material softening when obtaining nanocrystalline Mg alloys.