Yes it does, but an outside image like that would definitely create a much larger scale lag lol. Also, there is no "zoom effect" on the iPod, so I could see it having problems with obtaining the information required to view your abnormally sized character. The people swarming you were increasing their own lag, not serverside lag. There really is no reason to discuss the effect of the occurrence. We can safely put it aside and call it history. 
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When there are a large amount of players in a small area, they all have to download each others data and graphic files they don't already have. Also, The card doesn't replicate every possible graphic.