Although I don’t know how it was done in the early days of X, the modern standard for this is part of the Extended Window Manager Hints. In EWMH, applications give the window manager a number of possible icons, generally in different sizes, as ARGB bitmaps (instead of, say, SVG format). The window manager or desktop environment can then pick whichever icon size it likes best, taking into account things like the display resolution and so on, and display it however it wants to (in its original size or scaled up or down).