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What happens is that the kobo software extracts the cover from ebooks, and caches them to disk with a specific directory structure and filename. Basically, what KU (and the calibre kobo driver) do is pre-seed that cache with thumbnails so the kobo software doesn't have to do it.
KU actually tells calibre what size cover to send. That size is the full screen resolution used when the ereader is sleeping etc. KU then downscales the cover to match the required size for the library and grid views and saves the files.
If you're curious, thumbnail cache is in .kobo-images.
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