Certain (but not all) thumbnails have been sort of proxied for a while, but it’s complicated. But for example if someone posts a link to some questionable content on imgur, your instance will have a copy of that cached (and never delete it, because… Lemmy reasons). The recent changes just mean you can now enable other images to be proxied, though this is disabled by default. This proxy has an age (a day or a week or whatever you set) and content is deleted if it hasn’t been accessed in that timeframe - this is in contract to the normal Lemmy image stuff that I believe still stays forever unless that was fixed recenty.

And many instance owners would be allergic to that as it leaves them on the hook for storing content

This is already a risk whether via the existing thumbnail storage or via user uploads. It’s a pretty common recommendation that you should never host a website like Lemmy on a home server, always use a VPS for this reason. Then make sure you understand your local laws as well.