Adding to muguy's advice: iCloud Drive is a folder on your Mac. If you see a folder, like Documents, there, then you are seeing the Documents folder on your Mac. Including Documents in syncing with iCloud just puts the Documents folder in the iCloud Drive folder instead of in your User folder. Otherwise, it's the same.
Things in your iCloud Drive are copied to iCloud.com where you can see them and use them from the browser. If you have other devices connected to iCloud, then the contents of iCloud Drive can be seen and used on those other machines, as well. But, the Documents folder is local to you. This applies to anything you put in the iCloud Drive folder.
With any folder on the Mac, if you drag a file from Folder A to Folder B, then the file disappears from Folder A and reappears in Folder B. So, just like any other folder transfer, if you drag a file from Folder A to the iCloud Drive folder, it will disappear from Folder A and begin living in the iCloud Drive folderr on your Mac. It will also be copied to the iCloud Drive folder at iCloud.com. If you drag a file from the iCloud Drive folder on your Mac to Folder B, then that file will disappear from the iCloud Drive folder everywhere, and only be available in Folder B on your Mac.
If you try doing this with two different services, then you set yourself up for infinite loops of each service copying a changed file, causing the other service to see a change and copying, so the first service sees the change and…
If you have "Optimize Mac Storage" turned on, then when your Mac's hard drive gets really full, some lesser used files will be removed to make room. When you need one of those removed files, the Mac will grab the copy at iCloud.com and copy it to your Mac where it will again become a local file. You always use local files. This should all happen transparently. Perhaps the biggest downside of "Optimize" is that backups may not include all your files. I don't do "Optimize" on my Mac, though I use it on my iPhone which has way less storage. To keep the room I need on my MacBook, I put stuff on a tiny (like 1 ounce) SSD that I carry around. I try to keep 20% of my internal drive free. Apparently, in Sonoma now, you can choose files to always keep local, and you can choose files to keep offloaded, but I haven't had experience with that yet.
(You guys weren't talking about Optimize, but I thought that I'd just throw it in…)