We can already create private instances that don’t federate for those niche communities;

That being said, creating a private instance is a relatively difficult hurdle. By providing private communities, an admin can take care of the hosting, along with all of the other communities, while those who want something more controlled and closed can have an easily accessible option. Plenty of people want their social media to have options for being relatively closed or relatively open, and I think it’s healthy to provide those options.

I hear you though on the lemmy-world community closing possibility (and similar) … that would easily be an abuse IMO and it’s not entirely clear what would or could happen.

To be fair though, the whole lemmy-world instance (or any other for that matter) could simply turn federation off at any point to the same effect you fear, so it’s arguably just part of the federation flexibility. In this case, any community mod has their hand on the switch for their community, which means we’ll probably see it get used in controversial circumstances at least once. But for any given community, going either private or local-only is sure to drop user engagement or be a PITA regarding managing the “approved users” list, so I can’t see it being a popular action TBH.