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Books are held in the cloud/library/archive/whatever and download to the device as needed. I usually have 25-30 books on my Paperwhite. I can see all the books in my library by viewing "all" or I can see just the books on my device by viewing "downloaded".
When you do a factory reset, your downloaded books are removed from your device. You have to downloaded them again. For me, that's not a big problem and I do a factory reset once or twice a year as maintenance. If some decides do have 1,337 books on their device it's more of a problem.
If you can't remember which books you've read and which you can't, you can keep a list of read versus unread in Goodreads or Calibre. I'm only 76 and can usually remember but if I forget and download a book I've read it immediately tells me I've read it in "percentage read".
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