Wrong isn't the right word. It's friggin' weird, though. For one, it's utterly unlike, as near as I can tell, literally everything else that's ever been awarded a hugo in that category. It's not really an individual work, it's very nature renders it basically impossible to complete, it's not so much any particular sort of content itself so much as a container for it... it's like giving a hugo award to book binding or somethin'. So on, so forth.
For two, at least by the wiki page on the category, it wasn't published or translated within the last calendar year (AO3's been around like a decade or so). Individual works within it were, but... still.
For three, it's not really anything specifically to do with sci-fi or fantasy, either. The stuff's heavily involved, sure, but it's not nearly as closely tied as most older/other winners seem to be. It's just a really odd choice.
It's not a bad thing, exactly (and it's not even remotely like I dislike AO3, even if I probably wouldn't mention it in polite company due to how much smut is on it and how extreme it can get*). Just weird. My reaction's varyingly intense confusion with a side of disappointment I probably won't be able to get the library I work at to mention it much or at all due to all the smut on it.
* I didn't check too hard on the other ones, but this might be the first hugo winner that qualifies as child porn in some countries 
Yeah, that decision made me lose a lot of respect for the award. You could generally trust that something (or someone) that picked up a Hugo or Nebula was pretty good SF. Now apparently we're giving 'em out to websites for hosting shitty slashfics and wish fulfillment fics that aren't even in the correct genre.
And "some countries" is pretty generous, considering that there are book-canon Sansa Stark/Sandor Clegane ASOIAF fics on AO3. Lord knows there's probably worse, but I have zero interest in finding out how bad it gets.
Addendum: as a librarian, people won't care about the smut. Most romances, urban fiction, and westerns are smutty as hell. Not to mention the actual pornography in the stacks (which usually gets hidden away in the low-800s (DDC) nonfiction with miscellaneous other prose that doesn't get cataloged as fiction for one reason or another). I recall seeing one book in the stacks of a building I used to work at that was very plainly a collection of stories about people fucking dragons from the cover alone. Pop it open and it was indeed a collection of stories about people fucking dragons. There was another that had a collection of pornographic stories, stuff like a man discovering an extreme sub kink, a high school girl cheating on her boyfriend with his father, &c.
What people will care about is you knowing what fanfiction is (good or bad -- you may also set off some old 80s-gen nerd that won't stop talking to you about it).
