Efforts involving therapeutic islet cell transplantation have been hampered by limited islet availability and immune rejection. In vitro transdifferentiation of human bone marrow-derived stem (hBMDS) cells into functional insulin-producing cells promises to provide a tissue source for autologous cell transplantation. In this study, we isolated hBMDS cells, developed a single-cell-derived stem cell line, and induced the cells to differentiate into islet-like clusters. These islet-like cells expressed multiple genes related to islet development and beta cell function (e.g., Pdx-1, Ngn-3, Islet-1, Neuro-D, Pax4, IAPP, and insulin) and produced insulin and C-peptide within these cells. These islet-like cells demonstrated time-dependent glucose-stimulated insulin release, and the ability to ameliorate hyperglycemia in chemically induced diabetic mice. However, these transplanted differentiated cells became tumorigenic in diabetic immunocompromised mice and their spontaneous transformation was confirmed by a marked increase in growth rate and inactivation of tumor suppressor genes (P21 and P16) by promoter hypermethylation. In conclusion, while hBMDS cells can be transdifferentiated into competent insulin-producing cells, and while such cell might be a potential source for autologous cell therapy for type 1 diabetes, caution is strongly advised in view of the neoplastic propensity of hBMDS cells, especially after a long-term culture in vitro.