According to the halachah, towels are not considered muktzeh on Shabat, and wrapping a pot of food with towels quite obviously does not involve fire or electricity, and does not have the effect of cooking the food. Seemingly, then, this should be entirely permissible on Shabat.
The Gemara of Shabat however, explicitly states that Hatmanah – insulating food – in a manner that preserves its heat is forbidden on Shabat. Many people are unaware of this halachah, and it often happens when there is a power failure, or if the food was taken off the blech and the woman then realizes that it will not be served for a while, that she will want to preserve the heat by wrapping it with towels or blankets. It is therefore important to instruct members of the household that insulating food is forbidden on Shabat.
If a woman mistakenly insulated food on Shabat out of ignorance of the halachah, the food may be eaten on Shabat. As long as one did not wrap the towels around the pot in intentional violation of the laws of Shabat, the food remains permissible and may eaten on Shabat.