I haven't personally used Overdrive yet; it's on my list of things to do that just haven't gotten done yet. I've looked into the process for putting books up; you can make them available in many different formats, be that PDF, mobi (kindle) or epub.
Personally, I don't think there's a problem selling to libraries. They purchase physical books; there's nothing wrong with purchasing licenses to rent out digital books. That said, I'm a big fan of libraries and the services that they provide so when I do start adding my catalog to Overdrive I plan to price it lower than through other mediums. Individual libraries purchase their own books, so if you price a book too high, then the libraries will decide they don't need to stock your book. I haven't looked into whether I can set up free books for specific libraries through that system yet or not (I like to donate copies of my paperback books to my local libraries) but I believe it's probably possible through their promotional tools.
The digital library market has changed quite a bit over the last couple of years, so once we are done researching the current best practices we will update this FAQ.