I wouldn't regard the files in iCloud as a backup. Sure, they can act as one (e.g. if your Mac gets stolen, sudden catastrophic hardware failure) because even if you lose the local copies the files will still be in the cloud, but if you deliberately delete a file locally (or alter it destructively) then the version on iCloud will inherit those changes as well, so you won't have a "good" copy in the cloud to restore. You need either a local backup (using TM, or something like SuperDuper / Carbon Copy Cloner) to help in that situation, or an alternative online backup service like BackBlaze. You don't say whether or not you're using the My Passport for TM or documents or both, but if you're using it for both I'd strongly advise using a separate drive for TM, it can cause issues if you try to put documents on a TM drive as well.
If you turn optimise off, the documents you have in iCloud will download to your internal drive (default location for locally-stored documents from iCloud Drive is ~/Library/Mobile Documents). The stuff on your external drive will not be getting stored in iCloud Drive.