Federation is where different service providers can communicate with each other, like how email works. Meaning, you could login to Gmail (whether gmail.com or custom domain) and send messages to users with accounts on non-Gmail IM providers (practically speaking this meant hobbyist, corporate, or university IM server deployments; Google was the only major consumer IM provider to adopt a federated protocol).

The shutdown is unfortunate news because the only way IM is going to be as open as email is if two major consumer providers step up and do it. We had 1 and just needed 1 more. Now we have 0.

Federation means not having to reinvent the chat wheel for the umpteenth time.... Who was that quote from - physicists stand on the shoulder of giants... software and IT stand on each other's toes. Sad but true.