Regenerative medicine is a novel scientific field that employs the use of stem cells as cell-based therapy for the regeneration and functional restoration of damaged tissues and organs. Stem cells bear characteristics such as the capacity for self-renewal and differentiation towards specific lineages and, therefore, serve as a backup reservoir in case of tissue injuries. Therapeutically, they can be autologously or allogeneically transplanted for tissue regeneration; however, allogeneic stem cell transplantation can provoke host immune responses leading to a host-versus-transplant reaction. A probable solution to this problem is stem cell encapsulation, a technique that utilizes various biomaterials for the creation of a semi-permeable membrane that encases the stem cells. Stem cell encapsulation can be accomplished by employing a great variety of natural and/or synthetic hydrogels and offers many benefits in regenerative medicine, including protection from the host’s immune system and mechanical stress, improved cell viability, proliferation and differentiation, cryopreservation and controlled and continuous delivery of the stem-cell-secreted therapeutic agents. Here, in this review, we report and discuss almost all natural and synthetic hydrogels used in stem cell encapsulation, along with the benefits that these materials, alone or in combination, could offer to cell therapy through functional cell encapsulation.