We should make residential proxies illegal
You gotta draw the line in the sand somewhere, VPNs are already morally dubious, but if you ban the most shady of VPNs, residential proxies, then you can at least guarantee service providers the right to deny service to proxy users, while allowing proxy users to use the proxy everwhere they are welcome in.
on a more serious note, it's just not really possible since most residential proxy sites are botnets :)
The way it works is that these pwned IoT devices sell themselves to paying customers as proxies. So the pwners are not the ones actually running the DDoS service/Ransomware distribution/malicious activities. Rather it's an economy where each malicious actor offers their specific service.
In this case IoT device pwners pwn the device, install a VPN server and place their devices on a marketplace where they charge cents per hour using cryptocurrency. Then whoever needs an anonymous IP address pays for a couple of hours of 10k ip residential addresses, and sends their traffic wherever they need to.
So both are true: DDoSers (and malicious actors in general) use pwned devices, but they also use VPNs
At the moment, that's what Cloudflare is doing. They're just not obvious enough, leading to people on forums (and here) asking "why do I constantly need to fill out captchas to enter websites".