Efficiently obtaining functional pancreatic islet cells derived from human embryonic stem (hES) cells not only provides great potential to solve the shortage of islets sources for type I diabetes cell therapy, but also benefits the study of the development of the human pancreas and diabetes pathology. In 2001, hES cells were reported to have the capacity to generate insulin-producing cells by spontaneous differentiation in vitro. Since then, many strategies (such as overexpression of key transcription factors, delivery of key proteins for pancreatic development, co-transplantation of differentiated hES cells along with fetal pancreas, stepwise differentiation by mimicking in vivo pancreatic development) have been employed in order to induce the differentiation of pancreatic islet cells from hES cells. Moreover, patient-specific induced pluripotent stem (iPS) cells can be generated by reprogramming somatic cells. iPS cells have characteristics similar to those of ES cells and offer a new cell source for type I diabetes cell therapy that reduces the risk of immunologic rejection. In this review, we summarize the recent progress made in the differentiation of hES and iPS cells into functional pancreatic islet cells and discuss the challenges for their future study.