favicon (short for favorites icon), also known as a website Icon, shortcut icon, url icon, or bookmark icon is a 16×16, 32×32 or 64×64 pixel square icon associated with a particular website or web page.Most of the people use 16*16 pixel favicon with ".ico" format.But,you can also use gif,png(image formats) aswell.

There are plenty of sites out there that generates a favicon for you when you upload an image.Do a Google Search for "free favicon Generator" and plenty of sites would come up or use one of these free services:

• http://www.genfavicon.com/
• Favicon Generator (Blogger Buster) 
• FaviconGenerator.com (right click image and choose “Save image as”) 
• HTML-Kit favicon generator (download as favicon package) – Enables you to create a static or animated favicon; you can even create a favicon quickly using your Twitter username 
  
  

Then upload it to a free image hosting site like ImageBoo .After uploading the file select the direct link given at the very bottom which should look like "http://www.imageboo.com/files/m06hie3vf8gdban6cuq1.ico", add that as the "favicon url" given in the below instructions.

Now,go to your blogger dashboard>layout>Edit html and look for this code which at the top the template:
Just after that line add the following codes, substituting 'favicon url' for the URL where your favicon is hosted:
Then save your template. Now when you view your blog in your browser, you should see your favicon appear beside the web address.