"Why would anyone consider cloud storage where the service provider has access to their files is beyond me."
Three reasons:
1. They don't know that.
2. They don't know what the alternative is.
3. They have looked at the alternative and found it more complex than they want.
Option 3 depends on what they're considering. For example, there is the option of self-hosting. That is nice, and it works pretty well for me, and I know how to manage the networking and configure the disks for resiliency inside a machine I built and software I installed. Not everyone knows how or wants to do those things. For example, my box is on a private network, and if I'm not on that network, I can only access it by connecting to the VPN I also set up. People who want their files accessible from anywhere but don't know how to have their own VPN endpoint are unlikely to do the same.
Alternatively, maybe they're considering some hosted service with encryption like the one you described. I've never used it, but I start wondering how key management works with this. Are you responsible for having keys on any machine that can read the files? Or does it depend on your ability to log in? If it is the latter, do you lose your data if you forget your password? If you don't, then it sounds like the encryption key is stored somewhere that's out of your control. If the data would be lost, that is a good sign that there is probably encryption, but it introduces a weakness if you need that password reset for some reason. If encryption is too easy, I start questioning its quality.
I don't use OneDrive, but I know people who do. Some may use it without thinking of the security, but others understand that it is not encrypted storage and treat it as a big, convenient, insecure disk. For a student, they aren't very worried about Microsoft taking a peek at their homework, and if their laptop breaks, they've got a copy of it that they can quickly pull down from somewhere else. There are many services that can be used for that, and doing it yourself would be nicer (and is what I did even as a student), but there is still a reason that someone might opt for it anyway.