ECN

What is an Electronic Communication Network (ECN)?

An electronic communication network (ECN) is an automated trading system that directly matches buyers and sellers of financial instruments like stocks, currencies, etc.

ECNs allow traders and investors to directly interact with the order book and publicly displayed bids/offers rather than routing through a human market maker. By connecting multiple parties electronically, ECNs brought more competition and transparency to modern financial markets.

How ECNs Work

ECNs operate by consolidating orders from their members/subscribers into an order book based on price/time priority. The system then automatically executes matching buy and sell orders at the best bid/ask prices available.

This computerized order matching provides faster and more efficient trade execution compared to traditional voice-based dealing through market makers.

Types of ECNs

There are different types of ECNs focused on various asset classes like stocks, options, forex, bonds, etc. Some major ECNs for equities trading include Instinet, Island, Archipelago (now part of NYSE), Bloomberg Tradebook, and Citadel Connect.

ECN Pricing and Order Execution

For pricing, ECNs may charge subscribers a commission or fixed fee per transaction. Alternatively, they use a “taker-maker” model where liquidity takers are charged while rebates are paid to makers of liquidity.

This incentivizes tighter spreads. Order execution on ECNs adheres to strict price/time priority based on order specifics like limit/market, adding transparency.

Benefits of ECNs

Key advantages of ECNs include:

  • Increased liquidity through combining multiple pools
  • Publishing quotes openly for tighter bid/ask spreads
  • Time/price priority ensuring fair order execution
  • Faster automated trading
  • Lower costs via bypassing intermediaries
  • Equal access for all participants.

This levels the playing field compared to traditional OTC voice trading.

ECNs vs Traditional Market Makers

Whereas traditional market makers would buy/sell from their inventory and profit from the bid/ask spread, ECNs connect multiple parties to trade directly with each other transparently based on the best prices available.

This open order book model challenged the quote-driven OTC market maker model by making pricing and liquidity more efficient.

Regulation of ECNs

In the U.S., the SEC regulates ECNs as alternative trading systems with rules around publishing firm quotes, integrating orders, disclosure requirements, fees, and access standards.

ECNs meeting certain trading volume thresholds must register as exchanges or belong to a self-regulatory organization to ensure fair and orderly markets. Other jurisdictions have similar oversight.

Alexander Voigt, CEO
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Alexander Voigt is the founder of DayTradingZ, was a regular contributor to Benzinga and has been featured and quoted on leading financial websites such as Investors.com, Capital.com, Business Insider and Forbes.