The vasodegenerative phase of diabetic retinopathy is characterized by not only retinal vascular degeneration but also inadequate vascular repair due to compromised bone marrow derived endothelial progenitor cells (EPCs). We propose that n-3 polyunsaturated fatty acid (PUFA) deficiency in diabetes results in activation of the central enzyme of sphingolipid metabolism, acid sphingomyelinase (ASM) and that ASM represents a molecular metabolic link connecting the initial damage in the retina and the dysfunction of EPCs. Type 2 diabetic rats on control or docosahexaenoic acid (DHA)-rich diet were studied. The number of acellular capillaries in the retinas was assessed by trypsin digest. mRNA levels of interleukin (IL)-1β, IL-6, intracellular adhesion molecule (ICAM)-1 in the retinas from diabetic animals were compared to controls and ASM protein was assessed by western analysis. EPCs were isolated from blood and bone marrow and their numbers and ability to form colonies in vitro, ASM activity and lipid profiles were determined. DHA-rich diet prevented diabetes-induced increase in the number of retinal acellular capillaries and significantly enhanced the life span of type 2 diabetic animals. DHA-rich diet blocked upregulation of ASM and other inflammatory markers in diabetic retina and prevented the increase in ASM activity in EPCs, normalized the numbers of circulating EPCs and improved EPC colony formation. In a type 2 diabetes animal model, DHA-rich diet fully prevented retinal vascular pathology through inhibition of ASM in both retina and EPCs, leading to a concomitant suppression of retinal inflammation and correction of EPC number and function.