Why is milk powder used in bread machine recipes?
Milk or milk powder are not strictly needed in bread recipes.  There are many formulas that omit it:  the minimal ingredients for a loaf are water, flour and yeast; salt is probably essential for a loaf that is tasty.

Milk (or milk powder) is a way of enhancing the dough to:


Make a softer loaf (due to the milkfat acting as a tenderizer by interfering with gluten production)
Add flavor to the loaf
Enhance browning of the crust due to the potential carmelization of the milk sugars


The use of milk powder as opposed to liquid milk may be just for convenience, or because there is sufficient hydration in the loaf from other reasons, so it avoids adding additional water as part of the milk.

You may choose to omit the milk powder, but you will lose its benefits.  Instead, I suggest you find one of the myriad bread recipes designed for bread machines that doesn't include it if you don't want to use it.

The cratering issue is likely to be unrelated to milk or milk powder.