Hi Tubeta
You'll need to verify that a client that connects is given the hotspot IP as it's DNS address. It should be assigned by DHCP.
Secondly, dnsmasq should be using the DNS server set in the Grase Hotspot config, not your ISPs DNS server unless that is what you have set.
By default, dig on the Grase server will probably use your ISP DNS servers, because the server itself isn't forced through dnsmasq. However all clients should be using dnsmasq.
You may want to turn on log-queries in dnsmasq, to verify that client requests are hitting dnsmasq.
Also, by default cache-size is 150, so if it's absent, it should be caching up to 150 names, your change will make it cache up to 1000 names.
/etc/dnsmasq.d/01-grasehotspot is only for extra stuff we add. The rest is a default dnsmasq config, which in a default install caches. Look in /etc/dnsmasq.conf for other settings.
Regards
Tim