I turned one of my boy's baby blanket into a keepsake pillow. If you're looking for my ideas to preserve your baby items here's a great article: 6 Creative Ways to Preserve Baby Items.
We have tons of blankets from when they were little and I was trying to figure out how to put them to good use. Especially since some of them have some sentimental value. Since my son has nose bleeds I decided the best thing to do was make it into a pillow case.
He loves collecting things so we put a pocket in it. The mouth is a pocket. He absolutely loves it. For the first 2 months he want it with him every where now it just stays on his bed.
I just folded the baby blanket in half and sewed around 2 sides of the blanket for a pillow case but for a pillow sew all three sides.
I used sturdy fabric glue to glue on the eyes, mouth and teeth. The mouth is actually a pocket, at my sons request.
I sewed on the red hair. You can sew the whole pillow instead of gluing it. But I had a long list of stocking stuffer gifts to make for my family so I glued as much as I could. It took me about 20 minutes to make this.