Back up not encrypted: Time Machine is backing up an encrypted disk to an unencrypted disk

Time Machine has to read the files and be able to copy them. So yes.. Time Machine is backing up as long as it is showing you completed backups and yes it can restore from unencrypted backup to encrypted disk.

However why don't you start using encrypted backups if it concerns you??

Time Machine allows encryption and has done so for ages and ages. It is totally unrelated to encrypted disk in the Mac. And you must never forget the password because it is not recoverable.

What does this mean

It means that the data on your Mac's hard drive is encrypted, but the backup of the Mac on the Time Capsule is not.

Is the backup happening or is it not

Time Machine is backing up

Will I be able to restore from an unencrypted backup?

Yes