Yes, as @JMichaelTX says, the Icon Chooser allows lots of customisation. And I do use Keyboard Maestro's Icon Chooser when I want to use an App icon. Like say, for Photoshop . Or if I just want a letter or standard symbol.
What I'm curious about (and maybe @peternlewis could answer?) is if it makes any difference if I use the Icon Chooser to add Photoshop's icon to a palette rather than grabbing that icon and pasting it into the Macro's image well (assuming the icon I'm pasting in is quite small).
Ever since I started using Macs I've loved the ability to change an icon for a folder or file on the Mac by just invoking its Get Info window and pasting a new icon into the icon well in that window. So, doing that in Keyboard Maestro feels natural to me. It also allows me to make my own icons and use those.
I like to use PNG files for my own custom icons and agree with @BernSh that it looks better to have icons with transparency.
I also have a "blank" icon which is just a small PNG with no image but transparent background for when I don't want to have any icon - to make a gap in the palette. I find this makes the Palettes easier to read.
Here is the PNG image file I use for that:
Blank.png.zip (1.8 KB)
I haven't managed to find any way to use Keyboard Maestro's inbuilt Icon Chooser to make a "blank icon". I wonder if that is possible?