With the advances in tissue engineering and regenerative medicine, various approaches have been developed for peripheral nerve tissue repair and regeneration. In the current study, we have synthesized a cryogel matrix from chitosan and gelatin incorporated with polypyrrole for neural tissue regeneration. The three-dimensional (3-D) cryogel matrix was fabricated to mimic the in vivo microenvironment and analyzed for stem cell differentiation. Isolated bone marrow stem cells (BMSCs) cultured on a 3-D cryogel matrix differentiated into neural lineage on the basis of scaffold properties, in a co-culture system and by treatment with the spent media of Neuro 2a cells. To validate the cell–cell contact and BMSCs differentiation, scanning electron micrography and fluorescent imaging were done, which revealed the differentiation of the BMSCs. Immunostaining and gene expression analysis showed the BMSCs differentiation in all of the three cases studied. However, BMSCs in the co-culture system showed increased neurotransmitter levels of dopamine (34%) and acetylcholine (16%) with a respective concentration of 2.04 ± 0.03 ng/mL and 15.06 ± 0.19 pg/mL. Based on these properties, an in vivo study explored the potential of the synthesized cryogel in regeneration of a 1.5 cm nerve gap in the sciatic nerve of rats for a period of 12 weeks. The biocompatibility analysis showed that the scaffold did not induce any adverse immune response. Moreover, the walking track analysis and electrophysiological and immunostaining analyses revealed enhanced sciatic nerve regeneration in comparison to the negative control group. This study reveals the regenerative potential of the cryogel matrix for peripheral nerve regeneration.