@Ziggy the issue occurs when using the new Video Page option. In a video page, you aren't adding videos using video blocks, you add your videos in a manner similar to adding blog postings to a blog page. Using a video page, you only have the option to add a thumbnail if the video is uploaded to Squarespace. If you instead use a link to a site such as Vimeo, you have no thumbnail option nor control over the way the thumbnail is displayed.
I am having the same issue. Bizarrely, some of my Vimeo thumbnails look fine, others are mis-sized and blurry. I have found several people mention the issue. No simply fixes that I have read.