LanCache DNS server not being used even when specified on FriendlyWrt

Is it the same system with your previous post?
Running Release Candidate versions can have unexpected behaviour, as it is not stable yet.
The R4S doesn't still support any stable version, so inevitably you'll have to either wait for it or tolerate the issues that appear in RC versions. You can use either of them, squashfs can revert to defaults easily if you mess it up, ext4 is more widely known. If in doubt go for the squash.