It works by essentially installing a whole "remote VSCode server" in the container and connecting to that. So all of the extensions and everything is installed

It works by essentially installing a whole "remote VSCode server" in the container and connecting to that. So all of the extensions and everything is installed in the container. Then when you open it up, it just mounts your source code, files and config files into that environment and connects to it. It is definitely somewhere between architectural overkill and very useful.