the OS is run from internal flash memory, and you can install a new OS by booting off an SD or CF memory card using a special diagnostics menu.
as long as the memory card is big enough (need 256MB card, FAT16 formatted), you're ready to go. these cards are pretty cheap nowadays, most people buy large cards. Note that a 1GB sd card is the largest supported in this diagnostics mode as far as I know.
once you've got the new OS on, you should be able to use up to 4GB sd cards, if you install the new kernel module from the C3200 which supports them.