The objective of this study was to fabricate and understand ethosomal formulations of diclofenac (DF) for enhanced anti-inflammatory activity using quality by design approach. DF-loaded ethosomal formulations were prepared using 4 × 5 full-factorial design with phosphatidylcholine:cholesterol (PC:CH) ratios ranging between 50:50 and 90:10, and ethanol concentration ranging between 0% and 30% as formulation variables. These formulations were characterized in terms of physicochemical properties and skin permeation kinetics. The interaction of formulation variables had a significant effect on both physicochemical properties and permeation kinetics. The results of multivariate regression analysis illustrated that vesicle size and elasticity of ethosomes were the dominating physicochemical properties affecting skin permeation, and could be suitably controlled by manipulation of formulation variables to optimize the formulation and enhance the skin permeation of DF-loaded ethosomes. The optimized formulation had ethanol concentration of 22.9% and PC:CH ratio of 88.4:11.6, with vesicle size of 144 ± 5 nm, zeta potential of -23.0 ± 3.76 mV, elasticity of 2.48 ± 0.75 and entrapment efficiency of 71 ± 4%. Permeation flux for the optimized formulation was 12.9 ± 1.0 µg/h cm(2), which was significantly higher than the drug-loaded conventional liposome, ethanolic or aqueous solution. The in vivo study indicated that optimized ethosomal hydrogel exhibited enhanced anti-inflammatory activity compared with liposomal and plain drug hydrogel formulations.