Type 1 diabetes (T1D) is caused by autoimmune destruction of pancreatic β cells. Mounting evidence supports a central role for β cell alterations in triggering the activation of self-reactive T cells in T1D. However, the early deleterious events that occur in β cells, underpinning islet autoimmunity, are not known. We hypothesized that epigenetic modifications induced in β cells by inflammatory mediators play a key role in initiating the autoimmune response. We analyzed DNA methylation (DNAm) patterns and gene expression in human islets exposed to IFN-α, a cytokine associated with T1D development. We found that IFN-α triggers DNA demethylation and increases expression of genes controlling inflammatory and immune pathways. We then demonstrated that DNA demethylation was caused by upregulation of the exoribonuclease, PNPase old-35 (PNPT1), which caused degradation of miR-26a. This in turn promoted the upregulation of ten-eleven translocation 2 (TET2) enzyme and increased 5-hydroxymethylcytosine levels in human islets and pancreatic β cells. Moreover, we showed that specific IFN-α expression in the β cells of IFNα–INS1 CreERT2 transgenic mice led to development of T1D that was preceded by increased islet DNA hydroxymethylation through a PNPT1/TET2–dependent mechanism. Our results suggest a new mechanism through which IFN-α regulates DNAm in β cells, leading to changes in expression of genes in inflammatory and immune pathways that can initiate islet autoimmunity in T1D.