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I am interested in offering subdomains to people who want them e.g. helloworld.mydomain.com or blah.mydomain.com.

It is pretty much how WordPress or Blogspot handle their subdomains but I would not be hosting anything - just pointing to the person's website host location.

If somebody was to upload illegal content to helloworld.mydomain.com - would all sites under mydomain.com suffer?

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If you are only hosting the domain then illegal content is not something you should concern yourself too much since the appropriate authorities will know how to lookup the A records where the files are hosted. It can however look crappy on your branding if you want one.

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