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The transplantation of porcine islets of Langerhans to treat type 1 diabetes may provide a solution to the demand for insulin-producing cells. Porcine islets encapsulated in agarose–agarose macrobeads have been shown to function in nonimmunosuppressed xenogeneic models of both streptozotocin-induced and autoimmune type 1 diabetes. One advantage of agarose encapsulation is the ability to culture macrobeads for extended periods, permitting microbiological and functional assessment. Herein we describe optimization of the agarose matrix that results in improved islet function. Porcine islets (500 IEQs) from retired breeding sows were encapsulated in 1.5% SeaKem Gold (SG), 0.8% SG, or 0.8% Litex (Li) agarose, followed by an outer capsule of 5% SG agarose. Insulin production by the encapsulated islets exhibited an agarose-specific effect with 20% (0.8% SG) to 50% (0.8% Li) higher initial insulin production relative to 1.5% SG macrobeads. Insulin production was further increased by 40–50% from week 2 to week 12 in both agarose types at the 0.8% concentration, whereas islets encapsulated in 1.5% SG agarose increased insulin production by approximately 20%. Correspondingly, fewer macrobeads were required to restore normoglycemia in streptozotocin-induced diabetic female CD(SD) rats that received 0.8% Li (15 macrobeads) or 0.8% SG (17 macrobeads) as compared to 1.5% SG (19 macrobeads). Islet cell proliferation was also observed during the first 2 months postencapsulation, peaking at 4 weeks, where approximately 50% of islets contained proliferative cells, including β-cells, regardless of agarose type. These results illustrate the importance of optimizing the microenvironment of encapsulated islets to improve islet performance and advance the potential of islet xenotransplantation for the treatment of type 1 diabetes.