All my images use the same thumbnail image and I can't drag and drop images into K2 like I should be able to. See the attached image of the media manager and all the thumbnail images are the same eventhough the actual images are different.

Hi. The media manager creates it's own thumbnails. These are used only in the media manager. These images have nothing to do with K2 images. When you add an image to a K2 Item, it will be resized accordingly to the category settings.