How do I set up a custom domain

You must already have an email account with your domain name. So if you have your own website, example.com, you can go to your website hosting platform and set up an email, you@example.com. You would change the MX records with your hosting platform to make your you@example.com email available to use in iCloud.

Yes, that would be nice, but this feature only allows you to use the features of iCloud with your existing domain email address. I suppose it's to streamline your emails with your Apple/iCloud account for those who want it.

You have to purchase a domain from any Internet domain provider such as GoDaddy. You DO NOT need web hosting services. You'd be looking for domain registration only. I personally use HostSilo because they're cheap and renewals don't go up in price. The price for a .com is going to cost about ~$10-15/yr to own depending on the domain registrar. When you purchase one from another company, they give you access to something called a "DNS manager" which allows you to input the settings necessary for it to work with Apple's iCloud mail. If you're not sure how to do this, ask a friend that is knowledgeable in domain and web-hosting to help you out, or ask the domain registrar where you bought your domain to assist with this. Apple can't do this for you because they rely on partner companies like Microsoft Azure, Google Cloud, and Amazon Web Services to host their services for them. Internet domain registrar companies are all different in their prices and back-end software options on how to change DNS settings, so Apple can't automate this for you either unless they partnered with a specific company to do it. The problem is that many domain registrars will offer some choices at a reduced cost, and others will offer very extensive options at very expensive prices, so it's difficult to pick a company that will appeal to everybody's tastes. It's also beyond the scope of a consumer-centric hardware and device company to offer backbone Internet services such as domain registration without getting into complicated and very expensive infrastructure themselves - it's a completely separate type of business.

If you go to GoDaddy and buy a domain and want email with it, or go to ProtonMail and want to use a custom domain, both of those options are going to cost extra money. Bottom line is that this gives people a choice of having personal domain email hosting with full calendar and contact syncing across all of their Apple and/or iCloud-supported computing devices, similar to other popular services like Google Workspace or Outlook.com custom domains or Exchange Online (ala Exchange ActiveSync). You only need to purchase a domain.

If you already have iCloud+ (paid iCloud services), you get a place to host that custom domain email without having to pay extra for email hosting elsewhere. A domain name is always going to be cheaper than email hosting from a hosting provider, so it's a way to save some money. And since your calendar and contacts are kept in sync too, it's better than limited POP3/IMAP mail that only does email syncing. ProtonMail and GoDaddy's basic email don't offer calendar and contact syncing on your iDevices without using janky third-party software.

If you're happy paying someone else for some email hosting services, nobody's pulling your arm to switch to iCloud+. It's just an extra choice.