A block-based image encryption algorithm using wave function and chaotic system is presented. A random sequence generated by the chaotic system is used to find the source point in the wave and produces a diffusion matrix for modular operation. In the encryption process, the keystream is dependent on both the plain-image and the secret key. It changes in each encryption round. Theoretical analyses and simulation results show the high security of the proposed method, including the large key space, fairly uniform histogram, zero correlation between neighbouring pixels, resistance to differential attacks, and high efficiency. Therefore, our algorithm is a practical scheme for digital image encryption.