[thw0rted]

I think your take is correct but doesn't answer the question about why this matching has to take place on the device, if it's only for photos that are going into iCloud, and the iCloud contents are already being stored unencrypted.

The only remotely plausible answer I've seen is that Apple wants to keep potentially-violating material out of their general storage, and flagged images are being sent to the review team instead of regular backup, but that's a pretty weak guess.