.
Given a working Knoppix 7.2 LiveUSB with reiserfs persistence to begin-with,
and unused space in /mnt-system/ equal to or greater than 40% the size of the
contents of current /KNOPPIX-DATA, my overlay update process is as follows:

1. Accumulate a group of changes in the persistence partition, /KNOPPIX-DATA.

2. Survey the contents of /KNOPPIX-DATA to see if some elements may be omitted
in preparing a compressed image overlay to replace the contents of /KNOPPPIX-DATA.
Compress the net group of changes and store the resultant compressed, read-only
KNOPPIX[n] file temporarily in /mnt-system.

3. Examine KNOPPIX[n] and determine that its size is (usually) <= 40% the
size of the net contents of /KNOPPIX-DATA, and that there is no file of this name
already in /mnt-system/KNOPPIX/. If so, then move KNOPPIX[n] into /mnt-system/KNOPPIX/
and reboot with noimage cheatcode.

4. If KNOPPIX[n] seems to correctly represent the now-off-line /KNOPPIX-DATA,
then use GParted to reformat the reiserfs partition and henceforth boot without
the noimage cheatcode. Reformatting should provide a new 'empty' persistence file
to allow further, un-compressed read/write storage of additional system changes.

I have added a function MakeOverlay to my /etc/profile with root:root privileges;
this function currently suppresses any files with cache or Cache in its name.
For example, to make KNOPPIX3 and store it in /mnt-system/, I use a command line
in a root lxterminal and enter the command, MakeOverlay 3. MakeOverlay is
defined as follows:

MakeOverlay() { # Cloop-compress & save /KNOPPIX-DATA as /mnt-system/KNOPPIX$1
ISO=KNOPPIX$1; ISODIR=/mnt-system/; ISOSRC=KNOPPIX-DATA
echo -e "Creating "$ISO"; patience, this may take some time..."
cd /; sudo mkisofs -x *[Cc]ache* -R -U \
$ISOSRC | create_compressed_fs -B 131072 -m - - > $ISODIR$ISO
echo ".done; "$ISO" additions from $ISOSRC saved to "$ISODIR"."
}

Relevant notes concerning this 'update' process:

An initially-CD-size Knoppix 7.2 LiveUSB may have up to seven such overlays added.
However, a single well-planned overlay may be entirely adequate to adapt a
standard Knoppix to one's own preferences.

Aside from the sizes of the two partitions, there is effectively no filesize limit
on the reiserfs partition, but one should be mindful that on /mnt-system
using Fat32, all files including each KNOPPIX[n] can be, at most, 4 Gb in size.

One may hesitate indefinitely after a step 2, retaining the most recent KNOPPIX[n]
merely as a compressed backup of a current /KNOPPIX-DATA, while deferring steps
3 and 4, the actual implementation of an immediate overlay update. I follow this
course as a means of recovering from a corrupted persistence file, should that
occur, and/or as a means to allow ajustments in the current /KNOPPIX-DATA before its
eventual compression and replacement.

Copyright TJ Hoye 2013, License GPL Version 2