Each server (AKA "Instance") is kind of like an email provider, or like a bunch of individual Reddit websites. On Lemmy a "Community" is their version of a subreddit. Each server/instance hosts its own communities, but if you have an account on one server, you can still subscribe, read and post on off-server communities.

Each server is a piece of the federation. Some Instances do not federate with all other instances though. I'm not sure if there are any instances that access every other instance.

I'm not sure about lemmy, but I know that on other fediverse projects like Mastodon there were some servers that were completely unmoderated, filled with terrible content and were defederated by most other instances. Most decent people don't want to see that stuff on their feed.