Most of my contact photos were chosen from photos on my computer, and then transferred to a "contacts" folder in the micro SD card in my GN2 (since I decided to keep media on the micro SD card).
Some time back I had an issue with my phone and decided to do a factory reset, then a restore using My Backup Pro. The restore files were stored on a separate micro SD card, which I inserted for the restore. Even after I re-inserted my usual micro SD card, all my contact photos were fuzzy. I concluded that since the folder of the actual contact pics was not available at the time of the reset and restore, the phone must have pulled thumbnails of the photos that it had stored in some other folder, and it never linked up with the originals when I reinserted that micro SD card. So I moved my folder of contact photos from the micro SD card to the phone's internal memory (to hopefully prevent this from happening again), and then manually changed my contacts to point to those photos. They are all nice and sharp again, and I hope will stay that way, even if I ever do another factory reset. I still keep all other media on the micro SD card.