Stupid question,  but what if I use a copyrighted character in my game? You know, something like Mega Man for example? I've seen some Jojo fangame in past jams, so I would assume that those things are somewhat allowed? Idk

That depends on your local jurisdictions interpretation of "fair use". Usually copyrighted work is off limits to anyone not authorized by the copyright holder, there are however some exceptions. Works for education, comentary or critique (parody) are allowed under the Fair Use Act in the US.

When using a copyrighted work you risk a DMCA. I forget if itch takes any further steps with your account, I read the agreement ages ago, but its not an experience that I would like to make even if I am in the right (at least that is the impression I got from watching youtubers struggle).

In summery technically you can (if you fulfill the requirnments or fly under the radar), but you can get in trouble especially if money is involved.