There are still apps compatible with 4.2.1. To more easily find them:
iOSSearch - search the iTunes store for compatible apps.
Vintapps 3.1.3 - paid app.
Apple Club - filter apps by iOS version.
The iPod does not have the hardware to support a higher iOS version. The 2G only has 128 MB of memory (RAM) compared with 256 MB for the 3G and 4G and 512 for the 5G.