We need Proxy Protocol v2 because it supports UDP.
Enable Proxy protocol · Cloudflare Spectrum docs
Use the Proxy Protocol to Preserve a Client’s IP Address
https://www.haproxy.org/download/1.8/doc/proxy-protocol.txt
I don't have a DNS server that supports the Proxy Protocol v2 with udp, I only use Postfix and Dovecot with the Proxy protocol with TCP.
Does Pi-hole still work as expected? -> No
Since the dns-port expects a proxy-protocol-header when the proxy protocol is enabled, normal clients can no longer connect. Only the proxies (e.g. dnsdist or haproxy) with activated proxy protocol can connect. But this is not bad, because clients in this setup never connect directly to pihole, but always via the proxy.