Answer: The Gemara (Shabbos 34a) writes that one can only insulate food (hatmana) providing that they use a material that doesn’t emit heat and that they do so before Shabbos. The Shulchan Aruch (OC 257:3) lists which substances are considered to be heat emitting, and therefore forbidden to place around one’s pot even before Shabbos. Rambam (Shabbos 4:3) explains that chazal were concerned that if one were to place their pot among the embers, they may come to stoke the coals.
Thus, one would be able to wrap a pot with tea-towels, provided they did so before Shabbos. The Shulchan Aruch (OC 257:8), however, writes that while one can leave a pot on a stove on Shabbos, one would not be able to wrap it with tea-towels even before Shabbos. While the tea-towels themselves don’t emit heat, they will insulate the heat coming from the stove.
For it to be considered a prohibition of hatmana, the insulation would have to cover the whole pot. Thus, if the tea-towels were not wrapped around the actual pot but draped over a couple of pots together with some air space between them, it would not be considered hatmana. Likewise, if the pot wasn’t fully covered so that a significant part of the pot was exposed, it would not be considered hatmana. It is permitted to cover a pot in such a manner even on Shabbos.
In conclusion, while one may not cover a pot tightly with tea-towels while it is on the stove or hotplate, one may do so if it isn’t on the flame providing they did so before Shabbos. Alternately, one may place a tea-towel over the pot on Shabbos providing it didn’t properly touch all the sides or left part of it uncovered.