More than 70,000 people were expected to descend on Victoria Park in Camperdown on Sunday for the day-long Fair Day festival.
But the discovery of recycled mulch contaminated with mulch this week and the lengthy process to remove it put paid to the marquee Mardi Gras lead-in event.
"It breaks our heart to see this Sunday not go ahead, but given the safety concerns, we must put our communities' well-being first," Mardi Gras chief executive Gil Beckwith said.
"This cancellation is a setback however, it presents us with an opportunity to unite and support one another more strongly."
Bonded asbestos was found in mulch at Victoria Park on Monday evening after the Environment Protection Authority found a link to a known supplier deep in the supply chain of one of the City of Sydney's contractors.
More dangerous friable asbestos was also found in another central Sydney park, the 22nd detection of the hazardous material across the NSW capital since January 2.
Further discoveries are possible with the City of Sydney from Wednesday testing another 32 parks where it believes a contaminated mulch product may have been used.
Mardi Gras organisers and council staff spent Tuesday trying to find an alternative location for Fair Day.
More than 70,000 people were expected to attend the Fair Day event as part of Sydney Mardi Gras. (Steven Saphore/AAP PHOTOS)
But the task of shifting and setting up six stages and 200 food, retail and community stalls within a week proved too difficult.
City of Sydney mayor Clover Moore said the decision to cancel Fair Day underscored the seriousness of the matter.
"The NSW government and the EPA must make sure this never happens again," she said.
"Fair Day is a pivotal part of the Mardi Gras calendar. But we have to put the safety of our community first."
Inner West mayor Darcy Byrne offered Camperdown Memorial Park, a former site of Fair Day, as a potential solution to resurrect the event.
"I don't underestimate the logistical challenges but we have to be proactive in these circumstances," he told ABC Radio.
Greenlife Resource Recovery, the supplier linked to many of the contaminated sites scattered across Sydney, denies its mulch was contaminated when supplied.
The company on Tuesday said its testing showed mulch stockpiled at its facility was free of asbestos contamination.
It has launched an appeal against a prevention notice issued by the NSW EPA after the watchdog determined it supplied the mulch used at the inner city Rozelle Parklands, the first site where asbestos-contaminated material was found.
Ross Fox, a lawyer representing Greenlife, said the company was "at risk of being made a scapegoat for failures in a complex supply chain for construction and landscaping projects".
More than 100 sites across Sydney have been tested, leading to at least 22 positive results for bonded asbestos.
The EPA probe has grown to involve 120 investigators, who are working to trace the supply of mulch.
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