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Exactly. If you select ‘local’ you’ll only see local communities but you’ll see other’s posts and comments on there. If you select ‘all’ you’ll see communities from all federated instances. The instances just share stuff between themselves as long as their federated. If there is a ‘bad’ instance then your local instance might decide to not federate with them.
Agreed, tools / protocols for merging communities or migrating them and user accounts between instances would be good. But it’s a nice start and I like that it seems like it’s going back to the old days of services like email, usenet and irc.