I tried using the large sqfs file on a USB device, but it appears it is being mounted as Type iso9660 and so fails.
If it was mounted as Type squashfs then I believe it would mount OK.
The mount Type is determined in the linuxrc file ..... but I don;t know what effect changing the mount Type would have on other functions.
Might be worth looking into ..... there may be an error in the logic ...... ?