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I am thinking about upgrading the firmware on the Raspbery Pi 512 using rpi-update. However, I can't figure out what updating the firmware does. Does it make the Pi more stable? Or faster? I can't seem to find an answer about it.

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It updates the kernel and firmware. It is just a script, take a look at it.

Take a look at this for an example of what rpi-update does.

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