Many folks running instances take donations. Folks are happy to toss up a few bucks to help cover costs. Similar to how people are happy to hop on patreon and support whatever creators on a monthly basis. That's where a lot of the core mastodon money comes from. There's also grants from orgs and governments too to contribute.

This isn't a new concept, and the internet has always had services that worked like this. Usenet, mirrored file repositories, etc. It wasn't until the early 2000s that many things started to become centralized, and we see how well that's worked out.