For those who don't understand why the Livejournal issue is such a huge thing, here's a quick rundown:
First off, Livejournal is a blog. Design-wise, it has two distinct advantages over the other blogging service (i.e. Blogger) and one minor nitpick in its favor. One is the fact that you can read everyone else's blog entries in one place: the Friend's Page. Of course over the years, this technology has been replicated (such as Google's Reader or a simple RSS feed). The other advantage is the fact that you could write private entries--that is entries which only a select few can read. The second advantages combines the benefits of privacy in what is ordinarily a public environment. When you combine that with the social design of a Friend's Page, you have a winning combo (read both public and private entries in just one place!). The minor nitpick I have is that at the time, LJ had this feature wherein you could input your current mood and the music you were currently listening to. It's not groundbreaking territory, but it was a feature that had a "coolness" factor to it at the time.
Of course while all those design elements seem to make LJ a winner, that's not its real asset. Because the fact of the matter is, LJ isn't unique when it comes to format. Services like Blurty and Greatestjournal have identical features. No, the winning formula of LJ is the fact that, as Worldserpent puts it, is the fact that it's centralized. A good number of bloggers are in LJ (and thus making the Friends page more usable--if you only know one person using LJ, the Friend's page isn't useful but if you know a hundred...) and more importantly, a good number of fandom are currently residing in LJ (and is the reason why I split off from Blogger and created an LJ account).
The demise of LJ would mean fracturing communities so to speak. Everything stops being centralized. That's also why migration to other similar services such as Greatestjournal isn't the perfect answer. It's only the perfect solution if everyone migrated there too.
Now we'll get to what LJ did wrong. There are two crimes here and I'll focus on the less obvious one: the fact that LJ suspended journals unexpectedly and without warning. I say unexpectedly because no one thought LJ would react to Warriors of Innocence. And I say without warning because hey, one day you wake up and you discover that the journals you used to visit aren't there anymore (or worse, your journal isn't there anymore). It's like suddenly coming home and discovering your house isn't where it was eight hours ago--it's supposed to be there!
The other crime LJ did is the fact that they suspended journals arbitrarily based on key words--a grossly unfair method. Did LJ have legal rights to do so? Yes, of course. But no one thought they'd actually do so (in the same sense that many companies will disavow themselves if their product doesn't work correctly but hey, we'll still complain even if it says in the contract we have no right to complain, right?). And then this is the point where the paranoia sets in: if LJ censors things like Lolita and child pornography (even fictional ones), what will they censor next? It's like Germany invading Poland. Is this the start of a World War, or simply an isolated incident?
Of course the nature of humans is that they foster the emotion called fear (whether justified or not). Julius Caesar was assassinated because of what he could possibly do rather than his actual actions. And despite Google's track record, people are hesitant about the company because of the amount of private information they're acquiring. And these are entities with a good past. LJ's history is less than stellar, and this specific action is in the realm of foul play.
There's a lot more things that can be complained about LJ, at why they didn't do anything about pedophiles from the very beginning, or to why they're only succumbing to such requests now--after being threatened the equivalent of bad media exposure. But the point is, LJ has started its censoring spree, and people are justly afraid/angry that they'll be next.