diff --git a/src/__phutil_library_map__.php b/src/__phutil_library_map__.php
--- a/src/__phutil_library_map__.php
+++ b/src/__phutil_library_map__.php
@@ -711,6 +711,7 @@
     'DiffusionSSHWorkflow' => 'applications/diffusion/ssh/DiffusionSSHWorkflow.php',
     'DiffusionSearchQueryConduitAPIMethod' => 'applications/diffusion/conduit/DiffusionSearchQueryConduitAPIMethod.php',
     'DiffusionServeController' => 'applications/diffusion/controller/DiffusionServeController.php',
+    'DiffusionServeControllerTests' => 'applications/diffusion/controller/__tests__/DiffusionServeControllerTests.php',
     'DiffusionSetPasswordSettingsPanel' => 'applications/diffusion/panel/DiffusionSetPasswordSettingsPanel.php',
     'DiffusionSetupException' => 'applications/diffusion/exception/DiffusionSetupException.php',
     'DiffusionSubversionSSHWorkflow' => 'applications/diffusion/ssh/DiffusionSubversionSSHWorkflow.php',
@@ -4434,6 +4435,7 @@
     'DiffusionSSHWorkflow' => 'PhabricatorSSHWorkflow',
     'DiffusionSearchQueryConduitAPIMethod' => 'DiffusionQueryConduitAPIMethod',
     'DiffusionServeController' => 'DiffusionController',
+    'DiffusionServeControllerTests' => 'PhabricatorTestCase',
     'DiffusionSetPasswordSettingsPanel' => 'PhabricatorSettingsPanel',
     'DiffusionSetupException' => 'Exception',
     'DiffusionSubversionSSHWorkflow' => 'DiffusionSSHWorkflow',
diff --git a/src/applications/diffusion/controller/DiffusionServeController.php b/src/applications/diffusion/controller/DiffusionServeController.php
--- a/src/applications/diffusion/controller/DiffusionServeController.php
+++ b/src/applications/diffusion/controller/DiffusionServeController.php
@@ -536,11 +536,52 @@
       $body = strlen($stderr)."\n".$stderr;
     } else {
       list($length, $body) = explode("\n", $stdout, 2);
+      if ($cmd == 'capabilities') {
+        $body = $this->removeMercurialBundle2Capability($body);
+      }
     }
 
     return id(new DiffusionMercurialResponse())->setContent($body);
   }
 
+  /** If the server version is running 3.4+ it will respond
+   * with 'bundle2' capabilit in the format of "bundle2=(url-encoding)".
+   * Until we maange to properly package up bundles to send back we
+   * disallow the client from knowing we speak bundle2 by removing it
+   * from the capabilities listing.
+   *
+   * The format of the capabilties string is: "a space separated list
+   * of strings representing what commands the server supports"
+   * @link https://www.mercurial-scm.org/wiki/CommandServer#Protocol
+   *
+   * @param string  $capabilities - The string of capabilities to
+   *   strip the bundle2 capability from. This is expected to be
+   *   the space-separated list of strings resulting from the
+   *   querying the 'capabilties' command.
+   *
+   * @return string  The resulting space-separated list of capabilities
+   *   which no longer contains the 'bundle2' capability. This is meant
+   *   to replace the original $body to send back to client.
+   */
+  public function removeMercurialBundle2Capability($capabilities) {
+    $bundle2_arg = 'bundle2=';
+    $bundle2_arg_len = strlen($bundle2_arg);
+    $capabilities_arr = explode(' ', $capabilities);
+    $arrindex = -1;
+    $found_bundle2 = false;
+    foreach ($capabilities_arr as $capability) {
+      $arrindex++;
+      if (substr($capability, 0, $bundle2_arg_len) == $bundle2_arg) {
+        $found_bundle2 = true;
+        break;
+      }
+    }
+    if ($found_bundle2 && $arrindex > -1) {
+      unset($capabilities_arr[$arrindex]);
+    }
+    $capabilities_without_bundle2 = implode(' ', $capabilities_arr);
+    return $capabilities_without_bundle2;
+  }
 
   private function getMercurialArguments() {
     // Mercurial sends arguments in HTTP headers. "Why?", you might wonder,
diff --git a/src/applications/diffusion/controller/__tests__/DiffusionServeControllerTests.php b/src/applications/diffusion/controller/__tests__/DiffusionServeControllerTests.php
new file mode 100644
--- /dev/null
+++ b/src/applications/diffusion/controller/__tests__/DiffusionServeControllerTests.php
@@ -0,0 +1,28 @@
+<?php
+
+final class DiffusionServeControllerTests extends PhabricatorTestCase {
+  // this was the result of running 'capabilities' over
+  // `hg serve --stdio` on my systems with Mercurial 3.5.1, 2.6.2
+  private static $hgCapabilitiesWithBundle2_351 =
+    'lookup changegroupsubset branchmap pushkey known getbundle unbundlehash batch stream bundle2=HG20%0Achangegroup%3D01%2C02%0Adigests%3Dmd5%2Csha1%2Csha512%0Aerror%3Dabort%2Cunsupportedcontent%2Cpushraced%2Cpushkey%0Ahgtagsfnodes%0Alistkeys%0Apushkey%0Aremote-changegroup%3Dhttp%2Chttps unbundle=HG10GZ,HG10BZ,HG10UN httpheader=1024';
+
+  private static $hgCapabilitiesWithoutBundle2_351 =
+    'lookup changegroupsubset branchmap pushkey known getbundle unbundlehash batch stream unbundle=HG10GZ,HG10BZ,HG10UN httpheader=1024';
+
+  private static $hgCapabilities_262 =
+    'lookup changegroupsubset branchmap pushkey known getbundle unbundlehash batch stream unbundle=HG10GZ,HG10BZ,HG10UN httpheader=1024 largefiles=serve';
+
+  public function testRemovingBundle2Capability() {
+    $controller = new DiffusionServeController();
+    $test_case = self::$hgCapabilitiesWithBundle2_351;
+    $expected = self::$hgCapabilitiesWithoutBundle2_351;
+    $actual = $controller->removeMercurialBundle2Capability($test_case);
+    $this->assertEqual($expected, $actual,
+      'Removal of bundle2 capabilty removes from list');
+
+    $test_case = self::$hgCapabilities_262;
+    $expected = self::$hgCapabilities_262;
+    $actual = $controller->removeMercurialBundle2Capability($test_case);
+    $this->assertEqual($expected, $actual, 'Removing does not modify legacy capabilities');
+  }
+}