Experts from US hospitals and institutions including Harvard University managed to transplant cells into mice, which immediately began producing insulin.
The team was also able to show they could prevent the cells being rendered useless by the body's own immune system, which was effectively "switched off" thanks to scientific work.
It means a cure for type 1 diabetes - which affects 400,000 people in the UK - could be much closer. Scientists are now working to replicate the results in humans with the condition.
The man who led that breakthrough - Harvard Professor Doug Melton, who has been trying to find a cure for the disease since his son was diagnosed with type 1 diabetes as a baby - also worked on the new studies.
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The human islet cells used for the new research were generated from human stem cells developed by Professor Melton.
"Encapsulation therapies have the potential to be groundbreaking for people with type 1 diabetes.
"These treatments aim to effectively establish long-term insulin independence and eliminate the daily burden of managing the disease for months, possibly years, at a time without the need for immune suppression," said Juvenile Diabetes Research Foundation (JDRF) vice-president of discovery research, Julia Greenstein.