After having already cancelled my subscription because of this (this isn’t even the first time Cursor randomly broke WSL support after an upgrade) I found out that the issue seems to be that there are now apparently TWO different WSL extensions. Specifically, Anysphere (Cursor) seem to have released their own WSL extension and installed it as part of an update.
The only reason I found out about this is because I opened the “Agents Window”, closed the permanently stuck loading window and then from there tried to re-open the WSL project which now gave me a small popup notice from anysphere.remote-wsl telling me that it needs to uninstall the other WSL extension (presumably the one from VSCode it used before) and reload the window in order to be enabled.
Clicking on “Uninstall & Reload” solved my problem - for now.
It’s worth noting that nothing else fixed this - even uninstalling didn’t fix it because I didn’t nuke my Cursor settings. I didn’t even get the popup when attempting to reopen projects normally. It only showed up after I had deliberately opened the Agents window and closed all other windows and then attempted to reopen the WSL project.