Fetal beta cells are a potential form of cell therapy for type 1 diabetes. To protect transplanted cells from cellular immune attack, microencapsulation using barium alginate can be employed. Whether microencapsulated fetal pancreatic cells will differentiate as occurs with nonencapsulated fetal pancreatic cells is presently unknown. It is suggested that such differentiation would occur in encapsulated cells, similar to previous experiments conducted using encapsulated embryonic stem cells. Streptozotocin-induced diabetic severe combined immunodeficient mice were transplanted with 5,000 to 38,000 fetal pig islet-like cell clusters (ICCs) within barium alginate microcapsules of diameter 300, 600, or 1000 microm. Viability, insulin secretion, and content of encapsulated cells were measured prior to transplantation. Blood glucose levels (BGL) were measured twice weekly and porcine C-peptide monthly. Encapsulated cells were recovered from mice at 6 months posttransplantation for analysis. Encapsulated cells became glucose responsive and normalized BGL within 13 to 68 days posttransplantation, with 5,000 to 10,000 ICCs required. Microcapsule diameter did not affect the time required to achieve normoglycemia. BGL remained normal for the 6-month duration of the experiments. After removal of grafts at 25 weeks posttransplantation, glucose stimulated insulin secretion of the explants was enhanced 96-fold, insulin content was enhanced 34-fold, and the percentage of insulin and glucagon positive cells increased 10-fold and threefold, respectively, from the time of transplantation. This study demonstrates that fetal pancreatic cells differentiate and function normally when placed within barium alginate microcapsules and transplanted.