Although cell-matrix adhesive interactions are known to regulate stem cell differentiation, the underlying mechanisms, in particular for direct three-dimensional encapsulation within hydrogels, are poorly understood. Here, we demonstrate that in covalently crosslinked hyaluronic acid (HA) hydrogels, the differentiation of human mesenchymal stem cells (hMSCs) is directed by the generation of degradation-mediated cellular traction, independently of cell morphology or matrix mechanics. hMSCs within HA hydrogels of equivalent elastic moduli that permit (restrict) cell-mediated degradation exhibited high (low) degrees of cell spreading and high (low) tractions, and favoured osteogenesis (adipogenesis). Moreover, switching the permissive hydrogel to a restrictive state through delayed secondary crosslinking reduced further hydrogel degradation, suppressed traction, and caused a switch from osteogenesis to adipogenesis in the absence of changes to the extended cellular morphology. Furthermore, inhibiting tension-mediated signalling in the permissive environment mirrored the effects of delayed secondary crosslinking, whereas upregulating tension induced osteogenesis even in the restrictive environment.