by grainy do you mean pixelated like it hasnt completely downloaded? If so, I am having the same problems, started about a month ago all of a sudden. My file transfer doesnt work either. What version of Messenger are you using 8.1 or 9 beta?
I am working with Yahoo on my issue. Best thing you can do is report the problem. From Yahoo messenger go to Help > Report a problem. The first time you will do this it will turn on diagnostic logging, then it will ask you to restart Messenger. Once logging is turned on, try photo sharing again and when you have the same issue, go back to Help >Report a problem, then it will upload the diagnostic files to yahoo for analysis. This should also open up a case for you with Yahoo Help and they should respond shortly. Be advised that I sent my logs to them over a week ago and still have not heard back from them. But if everyone reports this issue, it just might get resolved quicker.
Also, you might want to try uninstalling Messenger (using add\remove programs), reboot your PC and then delete the c:\program files\yahoo!\messenger folder. ONce this is done try reinstalling it. Also during installation make sure your antivirus software is turned off during the install process. Hope this helps.