Well, it's clearly not a disk space issue.
You should take a look at /var/log/tinydns/current to see if the DNS server is telling you why it's not working.
You probably also want to open a bug in the bug tracker (don't think that you're claiming that SME has a bug, just think that you have a puzzle that a) the developers may be able to solve quickly, b) from which others might benefit, c) that could possibly be resolved through code changes or documentation)...