When I turn iCloud off I get that warning asking if I want to keep a copy on my Mac (or iPhone).
If I indeed keep a copy, what happens if I then turn iCloud on again and the copies are still there? Will iCloud know that the files are the same on both locations (locally and iCloud) and ignore them?
Also, what happens if I change some of those files while iCloud is off? Will iCloud keep the most recent copies? Will it overwrite with the ones remotely (old versions)? Will it rename the duplicates of the files on one of the locations and keep both versions?
So when I turn it off and it asks if I want to keep a copy, it automatically creates the iCloud Drive (Archive) folder with all the content? Is that what you mean?
So when I turn it back on, the original folder will be empty and only the remote files will be transferred?
According to what @polemarxos said, it asks to merge the data, so it seems that the files are not moved, even though I remember seeing the Archive folder when I was trying to sync after signing out.
If you turn off iCloud and make any changes to Calendar or Contacts, or Notes, etc. these changes will be merged with their copies in iCloud when you turn it back on. If you turn off iCloud, keep a copy, and an “iCloud Drive (Archive)” is created on your internal drive changes made to this folder will not be merged when you turn iCloud back on.
The “iCloud Drive (Archive)” folder that is created when you turn off iCloud is a standard folder that is no longer associated with iCloud. So, for example, if you made changes to a Numbers file in the (Archive) folder or added some files, etc. you will need to copy the changed/added files to iCloud Drive manually if you turn iCloud back on.
Think of it this way, some people choose to turn off iCloud permanently. If you do you can still use Apple Notes and Contacts, etc. because copies of your data was saved in these apps. The iCloud Drive (Archive) folder is just a copy of the files you had in iCloud Drive.