T cell responses against insulin-secreting pancreatic β cells are a hallmark of type 1 diabetes (T1D). A B7-like negative co-stimulatory molecule, V-set domain-containing T cell activation inhibitor-1 (VTCN1), can inhibit T cell activation. Here, we unravel a general deficiency within the VTCN1 pathway that is shared between diabetes-prone mice and a subset of T1D patients. Gradual loss of VTCN1 from antigen-presenting cells and pancreatic islets progressed alongside natural T1D development potentiating hyper-proliferationof diabetogenic T cells. Mechanistically, the loss of membrane-tethered VTCN1 relies on proteolytic cleavage mediated by the metalloproteinase nardilysin (NRD1). A cleaved soluble VTCN1 fragment (sVTCN1) was detected at high levels in the peripheral blood of 47% of pediatric T1D patients, compared to 4% of healthy subjects. Blood sVTCN1 levels correlated with the pace of disease progression highlighting potential use of sVTCN1 as a new T1D biomarker, and identifying NRD1 as a potential therapeutic target.