What is the output of
mount
df -h
when the device is running?
My guess is that the image is too large and you don't have a persistent overlay.
From a NOR-based device (with larger flash), seeing
/dev/mtdblock4 on /overlay type jffs2 (rw,noatime)
(rather than tmpfs) mounted on /overlay tells me that the MTD flash is being used for the overlay, not just RAM-backed temporary storage.
jeff@garage:~$ mount
/dev/root on /rom type squashfs (ro,relatime)
proc on /proc type proc (rw,nosuid,nodev,noexec,noatime)
sysfs on /sys type sysfs (rw,nosuid,nodev,noexec,noatime)
cgroup on /sys/fs/cgroup type cgroup (rw,nosuid,nodev,noexec,relatime,cpu,cpuacct,blkio,memory,devices,freezer,net_cls,pids)
tmpfs on /tmp type tmpfs (rw,nosuid,nodev,noatime)
/dev/mtdblock4 on /overlay type jffs2 (rw,noatime)
overlayfs:/overlay on / type overlay (rw,noatime,lowerdir=/,upperdir=/overlay/upper,workdir=/overlay/work)
tmpfs on /dev type tmpfs (rw,nosuid,relatime,size=512k,mode=755)
devpts on /dev/pts type devpts (rw,nosuid,noexec,relatime,mode=600,ptmxmode=000)
debugfs on /sys/kernel/debug type debugfs (rw,noatime)
See also