I am sorry to say I couldnt quite grasp the idea of locking xby coins in node

What does it means to coins stored in paper wallets or xchanges? Do that too get locked up and not be available for trade?

Only the coins of people who want to run a node (and have enough XBY to do it) will get locked up - coins stored on paper wallets or in exchanges will be available and ready to trade.
Exactly, only the coins of people who want to lock them up in their wallets and run a node will actually be taken out of circulation. Everyone are free to trade their coins when they want to.