By default it uses generated by WordPress thumbnail for the first image appeared in the post, that was uploaded on the server with sizes as set in Media settings. You can select between ‘thumbnail’ and ‘medium’ size options. In addition if your theme supports Post Thumbnails feature introduced in WordPress 2.9 you can specify custom thumbnail size. You can also specify post custom field name to be used as thumbnails source.
Thumbnails are arranged in columns under the post with related posts title/excerpt under each post thumbnail. Colors of background, border, text, text sizes, background on mouse over, title and excerpt length can be customized. See screenshot.