Synthetic hydrogels represent highly controlled environments for three‐dimensional culture of human mesenchymal stem cells (hMSCs). Encapsulated hMSCs are presented with a “blank” environment, and this environment can be closely controlled in order to elicit an osteogenic response. In vitro, dexamethasone is an efficient and reliable factor that leads to the osteogenic differentiation of human mesenchymal stem cells (hMSCs). The aim of this work was to develop a dexamethasone‐releasing poly(ethylene glycol) (PEG)‐based hydrogel scaffold to deliver dexamethasone to encapsulated cells in a sustained manner. To accomplish this goal, dexamethasone was covalently linked to a photoreactive mono‐acrylated PEG molecule through a degradable lactide bond, and this molecule was covalently incorporated into the PEG hydrogel during photopolymerization. Over time, hydrolysis of the ester bonds resulted in dexamethasone release from the gel. The biological activity of the released dexamethasone was verified in monolayer cell culture and in three‐dimensional culture (i.e., in the gel) by the ability of hMSCs to express osteogenic genes, including alkaline phosphatase, osteopontin, and core binding factor alpha 1, as measured using real‐time reverse transcription polymerase chain reaction (RT‐PCR). These studies indicate that encapsulated hMSCs are capable of osteogenic differentiation in response to released dexamethasone. © 2005 Wiley Periodicals, Inc. J Biomed Mater Res, 2006