Should I keep the sponge in?
YES! Keep the sponge before the return pump to protect it from any loose macro algae. Keep it clean to avoid the risk of nitrates. Keep a spare, swap them out during water changes so you are replacing with a sponge that is clean, and dried out killing all harmful detritus.
Where should my water level be in chamber two?
At the first, top shelf of the Media Basket. Disregard the MIN/MAX line of the aquarium. You need a higher water level in the rear chambers for proper filtration and water volume. Please add new water to the 2nd or 3rd chamber while the filtration pump is ON so the level comes up to around the first, top shelf of the Media Basket. Most set it just under the Filter Floss to avoid a waterfall noise.
Can I use this next to a Protein Skimmer?
Do not use alongside a protein skimmer. The fuge basket is not four sided and macro algae can be sucked into the skimmer's pump. If you would like a skimmer combined with a fuge, purchase the Media Basket. It will protect the algae from the pump and give you a spot for filter floss! Disregard the MIN/MAX line on the tank. It is not needed in a reef setup. Please add new water to your second or third chamber so that the level is just under the top of your basket or at the first, top shelf of the Media Basket.