It's specifically when "an image" is in the clipboard. Which is distinct from "a file" being in the clipboard, even though that file might contain an image.
The most accessible example would be to open some other site in a tab of your browser, find an image on that site, right-click that image and select "Copy image" (or depending on your browser, it may be "Copy", or maybe "Copy background") and then switch back to your phpBB Reply/Post editor and select Paste. This will cause the image data that is in the clipboard to be uploaded to the phpBB server and added to your message as an attachment.
Right-clicking a file on your desktop and selecting "Copy" (like you would also do for copying that file to another folder or to another drive) doesn't put "image data" into the clipboard. It puts "description of a file and it's path" into the clipboard, which doesn't provide you with "an image you can paste", even if the content of that file happens to be an image.
If that's already everything you were expecting, maybe confirm what platform you're on, what browser, and what the source of the image in the clipboard is.
The ability of this extension to do it's work is also contingent on
the Javascript implementation of the clipboard APIs in the browser. It's also contingent on whether a given platform puts "image data" into the clipboard, or allows "image data" to be pasted into a text editor.
One of the forum threads I believe identified that IE11 does not permit "Paste" actions in an edit box except for text-based clipboard data, and I believe the same for Opera on iOS. I can also vouch for Chrome on Android 7.x not actually putting "image data" into the clipboard, even when taking a screen shot of the screen.
But if you're on Windows 7+ with Firefox, Chrome or Edge, I can at least vouch for the success of those platforms, if image data is what was actually in the clipboard.