Chronic Dev Team has launched greenpoisOn which supports iOS 4.2.1 and iOS 4.1. So you need to first update your iPod Touch with iOS 4.1 or iOS 4.2.1 to use greenpois0n.
Here are the following step and instructions to jailbreak your iPod Touch:
Note: Make sure that you have the latest version of greenpois0n.
Next connect your iPod Touch to the computer and power it off.
Press and hold the Sleep/Wake button for 3 seconds.
Keep holding the Sleep/Wake button and also simultaneously also press and hold the Home button for 10 seconds.
You will then be prompted to release the Sleep/Wake button but continue holding the Home button.
Once the iPod Touch enters DFU mode, greenpois0n will start the Jailbraking process, but remember to keep holding the Home button.
Once the jailbreaking is complete, you will be prompted to release the Home button.
Click Complete button to close the application. You should see text in verbose mode scrolling on your iPod Touch’s screen.
Your iPod Touch will reboot. After it has rebooted, you’ll notice that there is a new Loader application on your iPod Touch’s home screen.
Tap on it to launch it. Select Cydia and then tap on Install Cydia button.
After you have successfully installed Cydia, you can uninstall the Loader application as it is no longer required. Tap on the Options button and then Remove Loader.app button to uninstall it.
That’s it, your iPod Touch is successfully jailbroken and you should see Cydia on the homescreen. Reboot your iPod Touch and launch Cydia to install the latest updates.
After Jailbreaking you can check on Jailbreak apps category page to find out the apps you can install on your iPhone using the Cydia app which is the App Store for jailbreak apps.