does image hosting site need powerful server?

it depends on the way you are going to store the images

if you're going to store it into a database then you need a powerfull CPU

if you're just going to store it into folders then all what you need is diskspace ,bandwidth and normal CPU and RAM

if you want my advice for a server that you can depend on with 100% uptime then try JaguarPC :

http://www.jaguarpc.com/r.php?a=23318.98

Personally, I'd toss the idea of using a proxy server. Put two NIC's in your server; one to the internet, the other to your intranet. That would force everyone to go through the server to get to the web, without configuring a proxy. ISA's complex to set up, but it works like a dream when you do it right. Then, use group policy for everything else (internet access, streaming media (through software restriction policies), etc.). The sweetness of group policy is that you can attach it to an OU and tweak it to your heart's content; modifying/restricting/controlling whatever you want. Then, as user's rights change, it's just a matter of throwing them into a different OU.

Image hosting basically means serving up lots of large, static files. So you need lots of disk space, lots of bandwidth, and not much else. A light weight webserver optimised for static files would probably be useful, Lighttpd for instance.

You'll need a very powerful server, or at least an efficient one. + a lot of hard disk space.