Which begs the question: What the hell was reddit doing that they didn't immediately implement an image hosting feature to keep users on the platform? Imgur rose to fame because it was the darling image host of reddit users, and it wasn't long before imgur needed to pay hosting costs and started sucking users away from reddit and into their own "imgurian" sharing hub.
I guess the internet back then was still in the "Open effort to make the internet awesome for everyone" phase, and hadn't yet gotten to the adversarial "Capture users and never let them leave" phase.
The problems are like you stated. We even see this happen with invalid dcma complaints in moderation-heavy environments. There are certainly safety rails such as rate limited reports per user, etc., but then you need some moderation anyway.
But if the legal requirement is, "take down media if the fbi comes knocking", maybe it's just easier to deal with it that way if there is no budget for moderation.