Very interesting approach!
The light atmosphere is unique.

I would change the grass against some of Loopix' plants. The row of grass in a single sprite doesn't work visually.
The same with the leaves of the tree, they need a modeled and more round shape without intersections to each other.

The steep slopes can get rid of the smearing when you save the terrain as a model too. You can change the uv-layout of the slopes then. Scale the distance between the opposing slopes a bit down and addit to the level.

The stones under the waterfall look good, but they need a transition to the environment.

All in all, this sort of small valley between steep slopes gives a certain suspense.
Did you try how it looks - especially the shadows - within a day night cycle?
Do you already have a gameplay or story for this?