This work investigates an application of the alginate encapsulation technology to the differentiation of embryonic stem (ES) cells into insulin-producing cells. It shows that the ES cells can efficiently be encapsulated within the alginate beads, retaining a high level of cell viability. The alginate encapsulation achieves approximately 10-fold increase in the cell density in the culture, in comparison to the two-dimensional conditions, opening a potential benefit of the technology in large-scale cell culture applications. Manipulations of encapsulation conditions, particularly of the initial alginate concentration, allow the control over both the diffusion of molecules into the alginate matrix (e.g. differentiation factors) as well as control over the matrix porosity/flexibility to permit the proliferation and growth of encapsulated ES aggregates within the bead. Post-differentiation analysis confirms the presence of insulin-positive cells, as judged from immunostaining, insulin ELISA and RT-PCR analysis. The functionality of the encapsulated and differentiated cells was confirmed by their insulin production capability, whereby on glucose challenge the insulin production by the cells differentiated within alginate beads was found to be statistically significantly higher than for the cells from conventional two-dimensional differentiation system.