The biggest reason IMO for moderation in the first place is because if you don't block/censor some people, they will block/censor others. Either by spamming, making others feel intimidated or unwelcome, making others upset, creating "bad vibes" or a boring atmosphere, etc.
So in theory, passing on moderation to the users seems natural. The users form groups where they decide what's ok and what's banned, and people join the groups where they're welcome and get along. Plus, what's tolerable for some people is offensive or intimidating for others and vice versa: e.g. "black culture", dark humor.
If you choose the self-moderation route you still have to deal with legal implications. Fortunately, I believe what's blatantly illegal on the internet is more narrow, and you can employ a smaller team of moderators to filter it out. Though I can't speak much to that.
In practice, self-moderation can be useful, and I think it's the best and only real way to allow maximum discourse. But self-moderation alone is not enough. Bad communities can still taint your entire ecosystem and scare people away from the good ones. Trolls and spammers make up the minority of people, but they have outsized influence and even more outsized coverage coverage from news etc.. Not to mention they can brigade and span small good communities and easily overwhelm moderators who are doing this for volunteering.
The only times I've really seen moderation succeed are when the community is largely good, reasonable, dedicated people, so the few bad people get overwhelmed and pushed out. I suspect Second Life is of this category. If your community is mostly toxic people, there's no form of moderation which will make your product viable: you need to basically force much of your userbase out and replace them, and probably overhaul your site in the process.