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For example if I'm selling a blankets:

incredibly.soft.blankets.mydomain.com

How would that affect my SEO? Would Google penalize me for this?

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Thatms unecessary, unhelpful, and annoying to users. There's no good reason to do this. –  John Conde Jul 13 '13 at 18:38
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Bad idea since Google addressed this issue awhile back, far too many webmasters were buying rich keyword domains and also making hundreds of rich keyword sub domains. Google rewards for SEF so no point in making sub domains or buying a domain with a keyword in.

Google wants more webmasters building a brand rather than stuffing keywords into the domain field, its now pointless to say the least.

If you create the sub domain with keywords Google will either not reward for the keywords or it may go against your site as a negative, no one truly knows exactly how Google puts the hammer down but what we do know is that Google loves Search Engine Friendly URLS so include your keywords in the URL path as Google loves...

A few resources on Google's EMD below:

Related Source: A question I answered awhile back

Google cares little for EMD 'Exact Match Domains', so there is little to no benefit in actually using keywords in the domain name

Additionally Resources:

Source: Search Engine Land

Well, it's official - no more free lunch for EMD, now that the Google EMD Update has launched. It worked well, for a long time. A whole industry of exact match domain tools and brokers came up. Huge premium prices for good names just went through the roof when it was a real “money keyword.” For quite a while, it was possible to rank in the TOP3 with literally no backlinks, compared to non EMDs, often after only a few days in literally every niche you can dream of. Exact Match Domains (AKA Keyword Domains) are, in general, domain names that exactly match the keyword.

Video: Matt Cutts explains keywords in domains pre EMD Update

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