Building upon our understanding of exchanges, ECNs and OTC markets, it's essential to consider the mechanisms by which these platforms facilitate transactions or financial instruments. We distinguish between quote driven and order driven markets here, and each system has its own set of protocols and market dynamics. Quote driven markets are characterized by the presence of market makers or dealers. These are entities or individuals empowered to provide liquidity by quoting executable bid, and ask prices for financial instruments throughout the trading day.

These market makers stand ready to buy or sell at the prices they declare effectively becoming the counterparty to trades when other participants wish to transact. OTC markets with their decentralized and flexible nature typically operate under this quote driven paradigm. In such markets, the market maker plays a crucial role in facilitating trades. This is especially the case in less liquid markets where market makers provide the necessary liquidity to execute trades that might not otherwise occur due to the lack of immediate buyers or sellers. So market makers provide a service by being ready to buy or sell at any time. So how do they get rewarded for this? They get rewarded by setting the price. They are willing to pay AKA the bid at a lower level than the price they are willing to accept. AKA, the ask or offer.

This bid offer or bid ask spread is where the market maker earns a profit. It's important to mention though that these profits are not risk-free or guaranteed. If a market maker, for example, buys a security, there is a risk that the market price declines before they're able to sell it on. So the spread can be seen as a compensation for the market risk taken.

Let's look at order driven markets next. They are distinguished by their use of an electronic order book that lists all buy and sell orders for specific instruments. Prices are dictated by the collective will of the market participants. Buyers indicate the maximum price they're willing to pay the bid while sellers indicate the minimum price at which they're willing to sell the ask. A trade materializes. When these bids and asks align leading to an execution, stock exchanges are often predominantly order driven, offering high levels of transparency. Since all market participants can typically view the anonymized orders of others allowing for informed decision making based on the depth of the market. To conclude, highly liquid financial instruments should find a conducive trading environment in order driven markets due to the transparency and perceived furnace that they offer. In contrast, instruments with less liquidity may benefit from a quote driven market where market makers can provide the needed liquidity, albeit at the cost of less transparency and less standardization.

In practice, many contemporary financial markets have adopted a hybrid approach integrating characteristics of both order driven and quote driven systems. For instance, a stock exchange may employ market makers to ensure liquidity and orderly market conditions while simultaneously maintaining electronic order book for the majority of its transactions. This hybrid model aims to leverage the liquidity provision of market makers with the transparency and efficiency of an order book, thereby optimizing the market for various trading preferences and security types.