This instance had problems with image uploads since the biginning. At some point admins figured out that automatic restarts few times a day solve some of the issues that appear when it's not restarted at all (including image uploading). But things still break anyway some time after the instance restarts, admins still are looking into what causes the issue. From what I've been told it seems that the issue doesn't exist on all other instances but only on some of them.

Here's a fun drinking game: take a shot every time image uploads break.

You're best bet is to use an external host (catbox, imgbb, etc) for images in posts, and to leave icons / bgs empty. For whatever reason, uploading images on Lemmy can be pretty buggy and this is the best solution.

Also are there size limits (in pixels or kilobytes) for image uploads?

Not AFAIK but keep it under 10 MB if you wanna be safe.