Actually the term toon has been around since 1981, in the novel Who Censored Roger Rabbit? the term toon was used to define the cartoons that inhabited the real world. They literally called them toons. When graphical mmorpgs came out (in the late 90s) people started referring their characters to toons because the worlds their characters lived in looked increasing more realistic, yet their characters still resembled cartoons.

Even though the term toon has become so widely used, most people have absolutely no idea about the real origins of the term 'toon'.

Also, for anyone not familiar with the book, it was adapted for the big screen in the late 80s as the movie titled Who Framed Roger Rabbit? which I'm sure most of us are familiar with. I'm also pretty sure they use the term toon in the movie as well.

So in reality though, the OP is actually only half correct in his assumption, the actual visualization would be a cartoon character in a realistic background.