Cell replacement therapy for type 1 diabetes (T1D), affecting millions of people worldwide, requires the immunoisolation of insulin-producing islets by encapsulation with a semi-impermeable material. Due to the shortage of donor islets, human pluripotent stem cell (hPSC) derived islets are an attractive alternative. However, properties of the encapsulating substrate are known to influence hPSC cell fate. In this work, we determine the effect of substrate stiffness on growth and pancreatic fate of encapsulated hPSCs. We precisely identify the range of substrate properties conducive for pancreatic cell fate, and also the mechanism by which substrate properties modify the cell signaling pathways and hence cell fate. Such information will be critical in driving regenerative cell therapy for long term treatment of T1D.