Successful transplantation of pancreatic tissue has been demonstrated to be an efficacious method of restoring glycemic control in type 1 diabetic patients. To establish graft acceptance patients require lifelong immunosuppression, which in turn is associated with severe deleterious side effects. Microencapsulation is a technique that enables the transplantation of pancreatic islets in the absence of immunosuppression by protecting the islet tissue through a mechanical barrier. This protection may even allow for the transplantation of animal tissue, which opens the perspective of using animal donors as a means to solve the problem of organ shortage. Microencapsulation is not yet applied in clinical practice, mainly because encapsulated islet graft survival is limited. In the present review we discuss the principal causes of microencapsulated islet graft failure, which are related to a lack of biocompatibility, limited immunoprotective properties, and hypoxia. Next to the causes of encapsulated islet graft failure we discuss possible improvements in the encapsulation technique and additional methods that could prolong encapsulated islet graft survival. Strategies that may well support encapsulated islet grafts include co-encapsulation of islets with Sertoli cells, the genetic modification of islet cells, the creation of an artificial implantation site, and the use of alternative donor sources. We conclude that encapsulation in combination with one or more of these additional strategies may well lead to a simple and safe transplantation therapy as a cure for diabetes.