How to draw a transparent bitmap

A portion of a graphic image that does not change the contents of the screen is termed "transparent."
The DrawIcon function can create an image that contains transparent portions.
It is also possible to obtain this functionality using the BitBlt function; however, there are some additional steps involved.
The first step is to obtain the contents of the area where the bitmap will be drawn and to store this background image in a memory display context (DC). Mask out the area of the background that corresponds to the nontransparent portion of the image bitmap and mask out all transparent pixels from the image bitmap. Use the XOR raster operation to merge the image bitmap into the background bitmap. Finally, use the BitBlt function to move the merged image to the destination DC.

procedure DrawTransparentBitmap(DC: HDC; hBmp : HBITMAP ;
          xStart: integer; yStart : integer; cTransparentColor : COLORREF);
var
      bm:                                                  BITMAP;
      cColor:                                              COLORREF;
      bmAndBack, bmAndObject, bmAndMem, bmSave:            HBITMAP;
      bmBackOld, bmObjectOld, bmMemOld, bmSaveOld:         HBITMAP;
      hdcMem, hdcBack, hdcObject, hdcTemp, hdcSave:        HDC;
      ptSize:                                              TPOINT;

begin
   hdcTemp := CreateCompatibleDC(dc);
   SelectObject(hdcTemp, hBmp);   // Select the bitmap

   GetObject(hBmp, sizeof(BITMAP), @bm);
   ptSize.x := bm.bmWidth;            // Get width of bitmap
   ptSize.y := bm.bmHeight;           // Get height of bitmap
   DPtoLP(hdcTemp, ptSize, 1);        // Convert from device
                                      // to logical points

   // Create some DCs to hold temporary data.
   hdcBack   := CreateCompatibleDC(dc);
   hdcObject := CreateCompatibleDC(dc);
   hdcMem    := CreateCompatibleDC(dc);
   hdcSave   := CreateCompatibleDC(dc);

   // Create a bitmap for each DC. DCs are required for a number of
   // GDI functions.

   // Monochrome DC
   bmAndBack   := CreateBitmap(ptSize.x, ptSize.y, 1, 1, nil);

   // Monochrome DC
   bmAndObject := CreateBitmap(ptSize.x, ptSize.y, 1, 1, nil);

   bmAndMem    := CreateCompatibleBitmap(dc, ptSize.x, ptSize.y);
   bmSave      := CreateCompatibleBitmap(dc, ptSize.x, ptSize.y);

   // Each DC must select a bitmap object to store pixel data.
   bmBackOld   := SelectObject(hdcBack, bmAndBack);
   bmObjectOld := SelectObject(hdcObject, bmAndObject);
   bmMemOld    := SelectObject(hdcMem, bmAndMem);
   bmSaveOld   := SelectObject(hdcSave, bmSave);

   // Set proper mapping mode.
   SetMapMode(hdcTemp, GetMapMode(dc));

   // Save the bitmap sent here, because it will be overwritten.
   BitBlt(hdcSave, 0, 0, ptSize.x, ptSize.y, hdcTemp, 0, 0, SRCCOPY);

   // Set the background color of the source DC to the color.
   // contained in the parts of the bitmap that should be transparent
   cColor := SetBkColor(hdcTemp, cTransparentColor);

   // Create the object mask for the bitmap by performing a BitBlt
   // from the source bitmap to a monochrome bitmap.
   BitBlt(hdcObject, 0, 0, ptSize.x, ptSize.y, hdcTemp, 0, 0,
          SRCCOPY);

   // Set the background color of the source DC back to the original
   // color.
   SetBkColor(hdcTemp, cColor);

   // Create the inverse of the object mask.
   BitBlt(hdcBack, 0, 0, ptSize.x, ptSize.y, hdcObject, 0, 0,
          NOTSRCCOPY);

   // Copy the background of the main DC to the destination.
   BitBlt(hdcMem, 0, 0, ptSize.x, ptSize.y, dc, xStart, yStart,
          SRCCOPY);

   // Mask out the places where the bitmap will be placed.
   BitBlt(hdcMem, 0, 0, ptSize.x, ptSize.y, hdcObject, 0, 0, SRCAND);

   // Mask out the transparent colored pixels on the bitmap.
   BitBlt(hdcTemp, 0, 0, ptSize.x, ptSize.y, hdcBack, 0, 0, SRCAND);

   // XOR the bitmap with the background on the destination DC.
   BitBlt(hdcMem, 0, 0, ptSize.x, ptSize.y, hdcTemp, 0, 0, SRCPAINT);

   // Copy the destination to the screen.
   BitBlt(dc, xStart, yStart, ptSize.x, ptSize.y, hdcMem, 0, 0,
          SRCCOPY);

   // Place the original bitmap back into the bitmap sent here.
   BitBlt(hdcTemp, 0, 0, ptSize.x, ptSize.y, hdcSave, 0, 0, SRCCOPY);

   // Delete the memory bitmaps.
   DeleteObject(SelectObject(hdcBack, bmBackOld));
   DeleteObject(SelectObject(hdcObject, bmObjectOld));
   DeleteObject(SelectObject(hdcMem, bmMemOld));
   DeleteObject(SelectObject(hdcSave, bmSaveOld));

   // Delete the memory DCs.
   DeleteDC(hdcMem);
   DeleteDC(hdcBack);
   DeleteDC(hdcObject);
   DeleteDC(hdcSave);
   DeleteDC(hdcTemp);
end;

The following is an example of how the DrawTransparentBitmap function might be called:

procedure TForm1.Button1Click(Sender: TObject);
begin
  DrawTransparentBitmap(Form1.Canvas.Handle, Image1.Picture.Bitmap.Handle, 10, 10, clWhite);
end;