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.
But the biggest impediment by far were internet transport costs. I mean, they're still onerous for a lot of media-heavy sites, but it was much worse at the time. Offloading that to third parties made an incredible amount of sense.
It's actually kind of bizarre that there is an Imgur "community". I know the operation ran at a massive money-losing proposition for quite some time.
They broke the social contract of being a trusted host, that's the biggest change.