Etcd plays a critical role in Kubernetes setup by storing the ever-changing state of clusters and objects, but its storage space is limited to 8 GiB, which can lead to performance issues if exceeded. To avoid outgrowing etcd's storage, it's essential to provision sufficient resources for each node, manage data size, split data across multiple etcd clusters, and ensure low-latency storage. Allocating enough memory and monitoring its utilization is also crucial, as well as clearing event objects from etcd and managing pod specifications. Additionally, deploying multiple etcd clusters can help mitigate the risk of events affecting cluster performance. Proactively maintaining etcd is vital to ensure healthy Kubernetes clusters.