One of the main factors contributing to water scarcity is water loss in water distribution systems, which mainly arises from a lack of adequate knowledge in the design process, optimization of water availability, and poor maintenance/management of the system. Thus, from the perspective of sustainable and integrated management of water resources, it is essential to enhance system efficiency by monitoring existing system elements and enhancing network maintenance/management practices. The current study establishes a smart water grid (SWG) with a digital twin (DT) for a water infrastructure to improve monitoring, management, and system efficiency. Such a tool allows live monitoring of system components, which can analyze different scenarios and variables, such as pressures, operating devices, regulation of different valves, and head-loss factors. The current study explores a case study in which local constraints amplify significant water losses. It develops and examines the DT model’s application in the Gaula water distribution network (WDN) in Madeira Island, Portugal. The developed methodology resulted in a significant potential reduction in real water losses, which presented a huge value of 434,273 m3 (~80%) and significantly improved system efficiency. The result shows a meaningful economic benefit, with savings of about EUR 165k in water loss volume with limiting pressures above the regulatory maximum of 60 m w.c. after the district metered area (DMA) sectorization and the requalification of the network. Hence, only 40% of the total annual volume, concerning the status quo situation, is necessary to supply the demand. The infrastructure leakage index measures the existing real losses and the reduction potential, reaching a value of 21.15, much higher than the recommended value of 4, revealing the great potential for improving the system efficiency using the proposed methodology.