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While it provides a level of mitigation, malicious actors can overwhelm the system as a whole by switching instances, creating new accounts, and other intentional actions. Moderation cannot scale indefinitely even with better tools.
If the vast majority of users moves to instances with stricter policies that will increase the moderation burden on those instances. Kind of like how on reddit the smaller subreddits were managed well and most of the trash were ruining the popular subs.
So the current solution works for now, and might scale better than a centralized system, but if it reaches a certain point it will either end up being fractured significantly or end up swinging back to centralization.
All of those are reasons I think lemmy's smaller population is a benefit right now and there is still plenty of room to grow.
I don't think the vast majority of users will ever be interested in the sort of atypical content that niche communities provide. They generally prefer the more mainstream stuff, it's kinda baked-in.
Also, I'm not talking about moderation, but federation. If you only federate with three instances, then only those three's users can interact with you. This does not increase any moderation burdens.