Thanks for writing the summary for the current image-proxying related issues. I prefer the "proxying images route" for better privacy, but its drawbacks sounds worse.
If Lemmy has a user-customizable setting like "Don't load external media automatically" (including images, videos, etc.), I'm happy with the "passing through external images" route.
You might want to try some Vertico extensions such as vertico-flat that displays completion candidates horizontally.