Twelve years elapse between the first and second acts, and during this time Count Arnheim has received no tidings of Arline, and has given her up as lost forever.  The act opens in the gypsy camp in the suburbs of Presburg.  Arline is seen asleep in the tent of the Queen, with Thaddeus watching her.  After a quaint little chorus ("Silence, silence, the Lady Moon”) sung by the gypsies, they depart in quest of plunder, headed by Devilshoof, and soon find their victim in the person of the foppish and half-drunken Florestein, who is returning from a revel.  He is speedily relieved of his jewelry, among which is a medallion, which is carried off by Devilshoof.  As the gypsies disappear, Arline wakes and relates her dream to Thaddeus in a joyous song ("I dreamed I dwelt in Marble Halls"), which has become one of the world’s favorites.  At the close of the ballad Thaddeus tells her the meaning of the scar upon her arm, and reveals himself as her rescuer, but does not disclose to her the mystery of her birth.  The musical dialogue, with its ensemble, “The Secret of her Birth,” will never lose its charm.  Thaddeus declares his love for her just as the Queen, who is also in love with Thaddeus, enters.  Arline also confesses her love for Thaddeus, and, according to the customs of the tribe, the Queen unites them, at the same time vowing vengeance against the pair.

The scene now changes to a street in the city.  A great fair is in progress, and the gypsies, as usual, resort to it.  Arline enters at their head, joyously singing, to the accompaniment of the rattling castanets, “Come with the Gypsy Bride;” her companions, blithely tripping along, responding with the chorus, “In the Gypsy’s Life you may read.”  They disappear down the street and reappear in the public plaza.  Arline, the Queen, Devilshoof, and Thaddeus sing an unaccompanied quartet ("From the Valleys and Hills"), a number which for grace and flowing harmony deserves a place in any opera.  As they mingle among the people an altercation occurs between Arline and Florestein, who has attempted to insult her.  The Queen recognizes Florestein as the owner of the medallion, and for her courage in resenting the insult maliciously presents Arline with it.  Shortly afterwards he observes the medallion on Arline’s neck, and has her arrested for theft.  The next scene opens in the hall of justice.  Count Arnheim enters with a sad countenance, and as he observes Arline’s portrait, gives vent to his sorrow in that well-known melancholy reverie, “The Heart bowed down,” which has become famous the world over.  Arline is brought before him for trial.  As it progresses he observes the scar upon her arm and asks its cause.  She tells the story which Thaddeus had told her, and this solves the mystery.  The Count recognizes his daughter, and the act closes with a beautiful ensemble ("Praised be the Will of Heaven").