That's not how it works. Instances don't cache images from other instances. If you hover your mouse over an image you can clearly see the site it's hosted on is in fact not originating from the instance you're browsing on. It works like Pleroma, Akkoma, Rebased, and other Pleroma forks.
IANAL, but I believe you can't be held liable for hosting links to other images on a site, regardless if they're embedded through the website's UI. They're not stored there, afterall. The client is rendering them.
All that gets cached, I believe, is the text and users from remote instances. And by cached, I mean stored in the postgres DB.
Unsurprising. All these companies have backdoors into your hardware and all it takes is someone with knowledge who's as unhinged as a reddit janitor to tell you, "Nuh uh. You can't use your spy devices you paid good money for because you violated our purposefully vague TOS."
With how all in Microsoft is on the ESG crap, I can see them locking you out of your Microsoft account (which is mandatory on Win11 btw) if they catch you being mean online.