The error its giving is an issue thats been going on with the lemmy client currently where errors are given as a string instead of json. Due to that don't know for sure which error you're running into with the image you're trying to upload

If you send me the image (I have matrix in my profile or you can link it here) I can do some testing with it to see. Worst case though you can upload to a third party service like imgur and then direct link to the image there