1. Within your Salesforce Org (outside of the community), navigate to the Libraries tab and click on the "Contribute" button.

2. Select the file you want to upload from your computer.

3. On the page you're brought to after selecting your file, select the 'Publish to a shared library' bubble under Sharing and select 'Asset Library'.

4. Click the "Publish" button at the bottom of the screen.

5. Once this is successfully published, navigate back to your community.

6. Within your community, instead of selecting the 'Upload Image' button, click on the "Asset Library" button to the right to locate your newly added image. Your image should display up top, as the list is shown in chronological order.

For additional reference, please review the following knowledge article (also mentioned in the known issue).