Mesenchymal stem cells (MSCs) are an important cell population in the bone-marrow microenvironment and are considered to be engaged mainly in the support of hematopoiesis. Recent work has shown that MSCs also have profound immunomodulatory function, both in vitro and in vivo. Because MSCs can be expanded rapidly to the numbers required for clinical application, several preclinical and clinical studies have been performed in the areas of immune diseases and bone-marrow transplantation. In this review we discuss the mechanisms underlying the MSC's immunomodulating properties and its potential applications.