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well it sounds like all you need to do is swap out the image as you said it puts a blue box with the filename there of the gif image so it sounds to me like you have it setup right
Basically for on the fly watermarks you can set the path to watermark image in Admin => Image Protection => Options and turn on the on the fly protection and watermarking
If you want permanent watermarking you can in Admin => Watermark Options set that to yes and specify the path in there. You would then go to Admin => Edit Categories and set the watermarking permission for each category for which usergroups get there images stamped with the watermark.
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