Do you use icondirect.php for it?

$tmp = new ElggFile();
$tmp->owner_guid = $user->guid;
$tmp->setFilaname("tmp/upload.jpg");
$tmp->open('write');
$tmp->write(file_get_contents($photo_url));
$tmp->close();

$user->saveIconFromElggFile($tmp);

$tmp->delete();

if i launch a lightbox that contains comments, will hypeinteractions still work in the lightbox?

It should

ok, thanks - there are reasons why i am not using hypeInteractions - but i don't recall exactly why now.. i will look at it again soon.

I was going to name the filenames as the entity guids, so I can easily link them to the entity. Then only allow mov or mp4 for uploads. What are the issues I can run into doing this using your method data directory?

There are plenty of issues you will run into, especially if you are not familiar enough with Elgg. 

Why don't you use latest Elgg version?

Current hosting supports up to 5.4 php and. Edited quite a few plugins... lack of time to move it and troubleshoot.