Foreign body response (FBR) to biomaterials compromises the function of implants and leads to medical complications. Here, we report a hybrid alginate microcapsule (AlgXO) that attenuated the immune response after implantation, through releasing exosomes derived from human Umbilical Cord Mesenchymal Stem Cells (XOs). Upon release, XOs suppress the local immune microenvironment, where xenotransplantation of rat islets encapsulated in AlgXO led to >170 days euglycemia in immunocompetent mouse model of Type 1 Diabetes. In vitro analyses revealed that XOs suppressed the proliferation of CD3/CD28 activated splenocytes and CD3+ T cells. Comparing suppressive potency of XOs in purified CD3+ T cells versus splenocytes, we found XOs more profoundly suppressed T cells in the splenocytes co-culture, where a heterogenous cell population is present. XOs also suppressed CD3/CD28 activated human peripheral blood mononuclear cells (PBMCs) and reduced their cytokine secretion including IL-2, IL-6, IL-12p70, IL-22, and TNFα. We further demonstrate that XOs mechanism of action is likely mediated via myeloid cells and XOs suppress both murine and human macrophages partly by interfering with NFκB pathway. We propose that through controlled release of XOs, AlgXO provide a promising new platform that could alleviate the local immune response to implantable biomaterials.