Embryonic stem (ES) cells have the ability to self-replicate and differentiate into cells from all three germ layers, holding great promise for tissue regeneration applications. However, controlling the differentiation of ES cells and obtaining homogenous cell populations still remains a challenge. We hypothesize that a supportive three-dimensional (3D) environment provides ES cell-derived cells an environment that more closely mimics chondrogenesis in vivo. In the present study, the chondrogenic differentiation capability of ES cell-derived embryoid bodies (EBs) encapsulated in poly(ethylene glycol)-based (PEG) hydrogels was examined and compared with the chondrogenic potential of EBs in conventional monolayer culture. PEG hydrogel-encapsulated EBs and EBs in monolayer were cultured in vitro for up to 17 days in chondrogenic differentiation medium in the presence of transforming growth factor (TGF)-beta1 or bone morphogenic protein-2. Gene expression and protein analyses indicated that EB-PEG hydrogel culture upregulated cartilage-relevant markers compared with a monolayer environment and induction of chondrocytic phenotype was stimulated with TGF-beta1. Histology of EBs in PEG hydrogel culture with TGF-beta1 demonstrated basophilic extracellular matrix deposition characteristic of neocartilage. These findings suggest that EB-PEG hydrogel culture, with an appropriate growth factor, may provide a suitable environment for chondrogenic differentiation of intact ES cell-derived EBs.