Blog contests are a simple and fun way to increase traffic and a sense of community on your blog. Let's face it. People love to win free stuff, and blog contests are a great way to create a buzz of excitement on your blog.
In the simplest terms, a blog contest is exactly what the term implies - a contest hosted on your blog. Since it's your blog, the nuances of the contest are entirely up to you. For example, you can determine the method of entry, duration of the contest, prize, and more. Again, it's up to you.
The most important thing to remember about a blog contest is it will drive traffic equivalent to the amount you promote it. In other words, if no one knows about your contest, they won't visit your blog to enter. Take some time to visit other blogs and websites to announce your contest. A quick Google search will reveal many blogs and websites that operate solely to announce blog contests. A great reference is About.com's Guide to Contests and Sweepstakes. Another great way to promote your contest is through blog carnivals.
Finally, make sure you understand the monetary investment inherent in a blog contest. Unless your contest is being sponsored by a company who donated a prize, you'll need to purchase a prize, and most likely, you'll have to pay shipping costs to send the prize to the winner.