The tremendous need for bone tissue in numerous clinical situations and the limited availability of suitable bone grafts are driving the development of tissue engineering approaches to bone repair. In order to engineer viable bone grafts, one needs to understand the mechanisms of native bone development and fracture healing, as these processes should ideally guide the selection of optimal conditions for tissue culture and implantation. Engineered bone grafts have been shown to have capacity for osteogenesis, osteoconduction, osteoinduction and osteointegration - functional connection between the host bone and the graft. Cells from various anatomical sources in conjunction with scaffolds and osteogenic factors have been shown to form bone tissue in vitro. The use of bioreactor systems to culture cells on scaffolds before implantation further improved the quality of the resulting bone grafts. Animal studies confirmed the capability of engineered grafts to form bone and integrate with the host tissues. However, the vascularization of bone remains one of the hurdles that need to be overcome if clinically sized, fully viable bone grafts are to be engineered and implanted. We discuss here the biological guidelines for tissue engineering of bone, the bioreactor cultivation of human mesenchymal stem cells on three-dimensional scaffolds, and the need for vascularization and functional integration of bone grafts following implantation.