What happens with Files On Demand turned ON or OFF is really quite simple.
Files On Demand turned ON = you control if cloud files are also duplicated locally. You can right-click on a file and choose if it appears locally or not. If you want to do something with a cloud file and it isn't already there locally, you click on it, and it immediately downloads to your local drive.
Files On Demand turned OFF = all files are mirrored in real-time locally and in the cloud at all Times. Files are always in BOTH places. Files are always in a real-time mirror with cloud and local. If you want to back up with Macrium Reflect for example, the files must all be physically there on your local drive, or they won't be part of the backup.
The default option is Files On Demand turned ON. Again, if you want to do something with a cloud file and it isn't already there locally, you click on it, and it immediately downloads from the cloud to your local drive to work with. If you right click on the file, you have an option to keep the file locally or not.