If you break that up you end up with only a few large and likely advertisement funded instances being able to survive.

I’m not saying I don’t think instances should be able to use that model, only that I think that model should not be the dominant way of building a community on the fediverse. But I don’t see why a user would be less attached to a community just because its hosted on a different server from them, especially on the threadiverse which is topic based and where users are most likely going to engage in multiple topics.

Super disagree. A community at the protocol level can have just as much character as a community at the network level, but without most of the drawbacks. The “instance as community” idea was always a poor substitute for actual Groups. The community shouldn’t be a server that users are bound to; it should be a Group that has access controls and private memberships (if desired). The moderators get all the same benefits of maintaining a limited community with their own rules, but users aren’t beholden to petty drama via instance blocks or defederation.

It wouldn’t change that, unless the moderators of those communities agreed to merge them by using the same cryptographic identity.