We propose a multilevel halftone-based color error diffusion (ED) algorithm. Our algorithm aims to achieve a “blue noise” color halftone by exploiting the interchannel relationship of a separated color image. The method focuses on dot distribution and dot overlapping control to yield high quality results. It treats color ED as a multilevel halftone and employs an embedded multilevel ED algorithm to determine the number of color dots in the processing pixel. In the color rendering process, the most suitable colors are selected as output based on the sum of the input and the error diffused from the processed dot. Experimental results show that the proposed algorithm generates high-quality halftone images with “blue noise” characteristics. Comparisons with state-of-the-art methods using objective and subjective measures show that our method is superior, as it effectively avoids dot overlapping and preserves the details of the original image.