See the knoppix Wiki:
USB Based FAQ: http://www.knoppix.net/wiki/USB_Based_FAQ
Ultimately you'll probably use the procedure located here:
Bootable USB Key: http://www.knoppix.net/wiki/Bootable_USB_Key
I did not follow this procedure, it was not available when I
made my bootable USB drive. It has a few more steps than what
I remember, but still looks straightforward enough...
If you use the procedure listed in the second link; the only
difference would be that since you aren't using an actual
CD or DVD (but the image instead), you'll need to mount the
image that you downloaded as a loopback device. If you are not
sure how to do that, see the first link and scroll down to the
part where you see "losetup" and use that instead, to mount and
copy the knoppix files to your USB device.
Note: Make sure you copy the /boot directory to the USB device
first as noted in the Bootable_USB_Key procedure.
PS: The DVD image is way more than 700MB, you must of DL'd the CD image...