Manual:$wgUseInstantCommons

Usage
Add the following to your :

Details
Settings this variable to true allows to automatically use in the local wiki images hosted in c>commons:|Wikimedia Commons.

It is a shorthand for the following setting to  :

Note
Enabling this parameter does not avoid any usage of disk space on the server running the local wiki.

This setting does indeed generate thumbs on the local disk for caching purposes.

In case the dimensions of the original file on Wikimedia Commons are exceeded when embedding the file on a page in the local wiki the file will in its original size be put onto the local disk.