In recent years, the potential of stem cells (SCs) to differentiate into various types of cells, including β-cells, has led to a significant boost in development. The efficiency of this differentiation process and the functionality of the cells post-transplantation are crucial factors for the success of stem cell therapy in diabetes. Herein, this article reviews the current advances and challenges faced by stem cell differentiation into functional β-cells for diabetes treatment. In vitro, researchers have sought to enhance the differentiation efficiency of functional β-cells by mimicking the normal pancreatic development process, using gene manipulation, pharmacological and culture conditions stimulation, three-dimensional (3D) and organoid culture, or sorting for functional β-cells based on mature islet cell markers. Furthermore, in vivo studies have also looked at suitable transplantation sites, the enhancement of the transplantation microenvironment, immune modulation, and vascular function reconstruction to improve the survival rate of functional β-cells, thereby enhancing the treatment of diabetes. Despite these advancements, developing stem cells to produce functional β-cells for efficacious diabetes treatment is a continuous research endeavor requiring significant multidisciplinary collaboration, for the stem-cell-derived beta cells to evolve into an effective cellular therapy.