This paper studies the competition between Web 2.0 communities in a game theoretic framework. We model three important features of these institutions: (i) firms' content is usually user-generated; (ii) consumers' content preferences are governed by local network effects, and (iii) consumers have strong tendencies to multi-home. Our analyses reveal that ex-ante identical community sites can acquire differentiated market positions that spontaneously emerge from user-generated content. Moreover, sites may obtain unanticipated and sometimes ambiguous market positions, wherein one site simultaneously attracts distinct and isolated consumer segments that seldom interact. Spontaneous differentiation reduces firm competition but may imply too much consumer segregation and lower social welfare. In most equilibria, a subset of consumers multi-home. We show that the degree of spontaneous differentiation increases in the localness of network effects. Interestingly, more multi-homing consumers imply reduced differentiation and intensify site competition. In one extension, we show that market growth tends to lead to lower market concentration, in contrast to the prediction by the classical horizontal differentiation model. We also study competing sites' community design strategies and provide conditions under which sites reduce or enhance user connectivity within their communities, leading to maximal and minimal spontaneous differentiation respectively.