Fairfax Media understands the AFL was concerned putting Mouncey in the AFLW semi-professional environment would unfairly "accelerate her development and increase her physical size".

But in a somewhat contradictory move, Mouncey will still be free to play in an AFL-sanctioned competition in Canberra despite her opponents being smaller and less-skilled than those in the AFLW.

Transgender athletes and lobbyists rallied around Mouncey on Wednesday after the AFL crushed her AFLW draft hopes.

The AFL says it took into account the maturity of the AFLW, it's player cohort and Mouncey's circumstances.

But it's understood the major fear was Mouncey would increase her strength rapidly - and at an unfair rate compared to other players - if she joined one of the eight AFLW clubs.

Mouncey is set to continue to play with Ainslie in the AFL Canberra competition next year and could nominate for the AFLW draft in 2019.

The AFL has cleared Mouncey to compete in community level competitions because football at that level is based around participation, inclusion, and involvement.

The AFL based its decision on the Victorian Equal Opportunity Act, which states that athletes can be discriminated against based on their sex or gender "if strength, stamina or physique is relevant".

Transgender rugby league player Caroline Layt, who represented New South Wales in women's State of Origin in 2008, said the AFL have sent the wrong message to the LGBTIQ community.

"They say play at the community level but don't dream too high, because your goals and dreams aren't going to be met because they're a bridge too far," Layt said.

"If her levels were off the charts then fair enough... She played all year at Ainslie, sure she's big and tall has good skills but she hasn't hurt anyone.

"I watched the AFLW last season and there are some pretty tough women that play and I don't think Hannah would have it all her own way.

"Ladies like Erin Phillips are amazing athletes in their own right and the female players don't have a problem with her, it's your trolls and keyboard warriors.

"They're guys who are no good at sport and think their whole manhood is threatened, while the people who made this decision just found legislation which has a loophole to discriminate."

Prominent Canberra advocate and advisor on transgender issues Peter Hyndal says the AFL has failed to "walk the walk" by ruling 27-year-old Mouncey ineligible.

"The thing that really just jars with the decision is they are saying you can't play in the AFL women's league but you are OK to play in Canberra," he said.

"What are they saying – that the average height and weight of Canberra women playing in that league is substantially different from the national league? I just don't believe that's true.

"The AFL's actions seemed to contrast with its recent history of progressive decisions. AFL has been one of those sports that has talked the talk and walked the walk.

"This decision does seem out of step for a sport that on the balance of things was fairly progressive in terms of inclusion."

While Mouncey has been blocked from playing in the AFLW, she is eligible to represent Australia at the Olympics in any sport.

Mouncey has represented Australia as a male in European handball and has been cleared to wear the green and gold in domestic and international competitions as a female.

Handball Australia has adopted the IOC transgender guidelines as endorsed at the IOC Consensus Meeting on Sex Reassignment and Hyperandrogenism in November 2015.

"We recognise and value inclusion and participation in sport at community and elite level and athletes meeting these guideline requirements are eligible to compete in our Australian sanctioned activities and events." a Handball Australia spokeswoman said.