It doesn't. Funkwhale is not meant to be run as a service for a large number of users. People running a pod should be cleared by fair use, much like someone with a iTunes library that is accessible through the home (or company) intranet.
It's a decentralized system, anyone can install and set it up. If I am running a pod and only give access to a few friends, how is that not fair use?
Mind you, this is only one of the basic cases. There are plenty of other use-cases for such a service that does not even involve copyright abuse. Imagine an indie label that sets up an instance to promote their artists. Or a music school that puts performance from their teachers/students.
There are plenty of ethical reasons for something like Funkwhale to exist, it's not on the developers to ensure that it is only going to be used in a way that doesn't cause the ire of the big-baddie RIAA.
I think you may already realise the royalties answer, but want to poke HN readers. That's fine, by me, but I think you also are aware that the majority of software developers here don't like digital locks on creative work so write digital keys to circumvent them. They do not believe in outright copyright, they do not believe in royalties. They are against corporate media streaming platforms, that pay a pittance to artists and labels, big and small.
That's basically music.
Questions of copying, design, originality, costing and ownership become more detailed, complicated, and fractious, the nearer you move the conversation toward to code.
No, not 'never use DRM' objects; sometimes we do. Many developers are youngsters, from disadvantaged backgrounds, poorer countries, barely scraping an existence from their non-privileged zone of society. After exerting all their energies on an idea and writing the code, will go the mainstream route just to 'get it out there', to put a toe on the ladder. They can't worry that their efforts will be circumvented, they would give up entirely.
So some things that come with caveats are worth investing in. And there is some good in the majors. Throwing out the bad without the baby is the tricky part.