We report the experimental observation of modulational instability and discrete breathers in a one-dimensional diatomic granular crystal composed of compressed elastic beads that interact via Hertzian contact. We first characterize their effective linear spectrum both theoretically and experimentally. We then illustrate theoretically and numerically the modulational instability of the lower edge of the optical band. This leads to the dynamical formation of long-lived breather structures, whose families of solutions we compute throughout the linear spectral gap. Finally, we experimentally observe the manifestation of the modulational instability and the resulting generation of localized breathing modes with quantitative characteristics that agree with our numerical results.