It’s not free, but it’s pretty cheap. When you don’t have to have massive marketing departments, huge management bonuses, expensive office space, crappy proprietary software, and massively scaled highly available platforms it costs a lot less to run a social media platform. Donations can often cover it all.

If one server gets too big, they can just cap registrations and people move to a different server.

No, it will never have ads. If the devs put ads in, it will get forked. If server admins put in ads, they will be defederated. That’s nonnegotiable if you want a free (as in libre) fediverse.

Mastodon is way bigger than Lemmy and it doesn’t need ads. Donations and subscriptions (for severs that choose that path) are enough.