FLAC is short for Free Lossless Audio Codec.
As the name imply it is an audio codec, which encodes without data loss (lossless) and is provided for free (no cost, and source code available). Nothing "special" about that, as there are many other lossless and free audio codecs out there.
You can get FLAC files in many ways:
* Rip Audio CDs
* Download online (buy or for free)
* Transcode from different format
* Other
The iPod touch do not support FLAC. It support ALAC (Apple Lossless) though
You can convert files bought from iTunes Store, but it is just a waste of time and storage space. Since files from iTunes Store is lossy AAC files, and hence lots of audio data were thrown away during encoding and are lost forever.
You are much better off getting "real" FLAC files using one of the methods mentioned above.