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What happens if I have both my updates posting to my blog as posts and my posts sent to Zannel? Will it cause the world to end in a spinning fireball of death?

Actually, Zannel Tools has taken this into account and you can safely enable both creating posts from your updates and updates from your posts without duplicating them in either place.

Does Zannel Tools use a URL shortening service?

No, Zannel Tools sends your long URL to Zannel and Zannel chooses to shorten it or not.

Is there any way to change the prefix of my blog posts that get updated?

Yes there is. The change is made in the code of the plugin, just look for and modify the following line: $this->zupdate_prefix = 'New blog post';

The reason this is done this way, and not as an easily changeable option from the admin screen, is so that the plugin correctly ignores the updates that originated from previous blog posts when creating the digest posts, displaying the latest update, and displaying sidebar updates.