Think of it as a VM, running within the source or target vShpere environment.
During the tasks assigned to it, after the processed VM snapshot it taken for backup purposes, the Proxy HotAdd VM mounts to itself now read-only VMDK files for processing of their data (CBT, ideally). Once processed some bits of data, deduplicated/compressed etc, it sends this data over to the backup repository or replication destination, depending on the task/job assigned. Upon all data processing finished for a VMDK, it "unmounts" this disk from itself, releasing it for snapshot removal at the final stage of the VM processing.
Since Proxy VM is a VM, it allows to process up to 60 VMDKs concurrently, provided you allocate sufficient vCPU resources and tasks limit per Proxy is set to allow so;
The added benefit is an ability to send backup traffic not through the management stack of vmkernel to the target repository/environment, but also have an option to choose alternative network (for example, ESXi MGMT network is limited to 1G NICs, while you happen to have 10Gbps NIC you may want to leverage for backup traffic in this case).
Product Architect @ SingleHop - Veeam Platinum Service Provider
VCAP-DCD, VCAP-DCA, VCP-NV
Veeam Certified Architect