It uses a new file system technique that allows you to stack filesystems. I believe Knoppix 3.8 will use UnionFS to stack a writeable filesystem on top of a read-only filesystem so that changes to the stack appear to be made to the read-only but are in fact saved to the writeable filesystem. See this article http://www.linuxjournal.com/article/7714 and the UnionFS project page http://www.fsl.cs.sunysb.edu/project-unionfs.html.