It will detect the circular features even if they are modeled by triangles in the STL file. It's pretty intelligent actually! Import a simple file like a cup or something and then turn on G2/G3 replacement. Slice and open the Preview. If you animate the build you'll see that the circular features are now printed in a single command instead of thousands of tiny ones.
The major benefit of using these G2/G3's is that those thousands of tiny linear moves suddenly become a single G2/G3 command. Saves tons of communication overhead and the firmware should theoretically be able to print the arcs better since they can use sinusoidal driving functions. However, the Marlin version that ships with most M2's has some serious issues executing G2/G3 movements. As others have noted, the machine will pause for a few seconds right before printing a arc while the 8-bit microcontroller processes what to do. So you should probably hold off on using the "Replace with G2/G3" option until you upgrade your firmware or unless you are using a different flavor that supports it better.
The radial arc compensation is a method to get better circles without using G2/G3. It's most useful for holes where it will automatically expand the linear segments outwards so that the inner diameter of the hole matches the design intent.
So if you're using a stock M2, you either have to turn off arc detection completely or maybe enable radial compensation if you have lots of holes that are coming out too small