[jocala]

I was always under the impression that xbmc used up the internal memory of the aftv. When I had all of my movies and tv shows going through xbmc, after a while, I started getting memory full errors and I had to constantly clear the cache just to run it. The thumbnails are in the folders on my computer, but doesn't xbmc load that stuff up in the internal memory of the aftv to make it come up faster? I swear I read that somewhere, and I think that's what I experienced.

Yes, that's right. Typically local disks are several times faster than network disks, so all artwork is resized and cached locally on first use.
Then you get the faster access times. It can require a few gigs of local storage for a reasonable sized library.

You can force the thumbnail to be located on a network drive (with pathsubstitution), but you will lose some speed.

I have all my local video files on my NAS and my Library setup with a networked MySQL database to store all movie and TV info, thumbs etc. In this case will XBMC still fill the local Thumb cache? Do I need to add the pathsubs setting in advsettings.xml??

MySQL doesn't store graphics, afaik. You'll still need pathsubs.