It creates a ramdisk and loads itself into memory, rather than running off the floppy.

As far as USB booting goes, there seems to be two competing formats, one that emulates a hard drive (USB-HDD) and one that emulates an Iomega zip drive (USB-ZIP). These formats seem to have something to do with the USB stick's geometry (link to Damn Small Linux article on setting your USB key's geometry).

There are also, of course, different bootloaders. Damn Small Linux has a script on the Live CD that installs itself to a USB key, using syslinux (it creates and boots from a FAT16 partition) and USB-ZIP geometry. Another cool-looking distro based on Kanotix named CPX-Mini installs GRUB to your USB key (it creates and boots from an ext2 partition) and uses USB-HDD geometry.

Unfortunately, CPX-Mini won't boot on my computer off the USB key, but Damn Small will. So my goal is to examine the Damn Small Linux script to see how they format and partition the key, then resize the partitions on the key to hold the larger CPX-Mini "KNOPPIX" loopback file. And use Syslinux instead of GRUB. Sort of piggybacking on the Damn Small Linux installation, if that makes sense.

As far as getting something bootable onto a 32MB USB key...here's a list of really tiny Linux distros, courtesy of MuLinux.