The black dye tubs were the result of a program called FUSE (Fallo's UO Server Emulator), which along with UOX (the Ultima Offline eXperiment) were server emulators.
The author of FUSE included a hidden setting in the loader program for the emulator that, when used on legitimate servers, would dye tubs black automatically. It took several weeks for it to be patched.
UO Extreme was called UOE, and its primary feature was the ability to see hidden players.
You have the gist of the story correct, but the details are all wrong.