Yes. Updates are handled by installing an entire new filesystem image,
and the device boots to the new filesystem. Most products that are
mission critical will have the ability to revert back to the previous
version if booting of the new filesystem fails, or the user decides the
new version is unsuitable (e.g. incompatibilities or interoperability
issues, etc).
Where is the previous version kept? On device? As long as there's
enough room you can do that with Baked - it would be a question of how
you put the Baked rootfs onto the device.
Yes, the previous version would be on the device. It needs to be in
case the update fails and an automatic fallback is required. Think of
remotely updating a router that is located in the middle of nowhere
(where maintenance personal visit infrequently).
There are a few ways of doing this. Each FS could live in it's own
partition, or images can be stored on a common partition and loaded
somehow (e.g. loop device). Kernel images may or may not live in the
fs, depending on the bootloader capabilities of the embedded system.
The kernel may or may not need to use initramfs.
As far as configuration is concerned. Most user settable values are
stored in a common location (e.g. an eeprom, or a dedicated partition,
etc). These values are used by the running linux system (which ever it
is). An example would be hostname, IP address, etc.