There is a bad mixing of terms here. The rootfs is where the kernel and all Maemo core software is stored, and runs from. This rootfs is little different from any other Linux root filesystem, and -is- the Maemo "firmware."

As far as Maemo (and Linux) is concerned, it's just another disk.

The physical size limitation is due to it being stored on a high speed chip that is only 256MB in size, which was the biggest available when the N900 was designed. So there is a reason for it.