Masquerade/Analysis

Why the Masquerade Endures
The masquerade is one of the biggest stretches of Willing Suspension of Disbelief, leading to uncomfortable questions such as "how can a corrupt, inefficient bureaucracy hide countless magical species?" and "why doesn't anyone notice the dozens of murders every night?". Superpowered secret societies never seem to consider conquering a country, nor does the renegade vampire hunter ever consider collecting a ton of evidence and spreading it to the whole world. One begins to wonder if the masquerade is less a necessity and more a cultural anxiety disorder.

There are almost as many Hand Waves as there are protests. The hidden world is too dangerous, or the human world is too dangerous. Humans vastly outnumber the hidden species and are completely intolerant. They're monsters that would dissect anything they capture. God told them not to. Despite all of these solutions and the further problems they bring up, there is a simple Doylist answer to it all:

Writers use the masquerade because it makes the audience feel special.

Stories set in a masquerade universally involve at least one normal human being pulled into it. Some might reveal the character to not be 100% human in the first place, but they always have a normal human backstory. Try and find a story that doesn't make said character an Audience Surrogate of some kind. The implication is that the audience is special and important enough to be brought into an awesome new world while all the mundane, meaningless sheep surrounding them are doomed to go through life oblivious and unfulfilled. They get to feel like they have an incredible secret, giving them a much greater depth compared to people in the office talking about Reality Television. It is not merely enough they are exceptional (e.g. a teen superhero); they operate on rules above and beyond Puny Earthlings. This is a trope born out of the selfishness of the average person.

(The added bonus of making said character an Audience Surrogate is giving the special characters a reason to explain all the stuff that goes without saying for them, thus providing exposition that would otherwise be clunky and out of place.)

The other reason for the masquerade is to keep the scale small and easily digestible. Most works that employ the masquerade are entry-level genre material and having to consider the global implications would alienate audience members already venturing out of their comfort zone. Harry Potter most likely would not have been so successful if it spent a chapter on the United Nations discussing ethical policy of the harvest of dragon parts for wands.

Masquerade as Cold War
Suppose you have vampires, werewolves, magic-users, fairies, excitable followers of who knows how many semi-obscure gods, Angels, Devils, and Squid. They have advantages, all right. But even if collectively The Hidden don't consider The Mundanes a serious threat, they have to deal with each other. Even with a single Hidden group, if they are human-like enough to blend in, they probably have a comparable inclination toward splitting into disagreeable factions.

Do you want to start all-out Armageddon or live your life (especially if it's indefinite)? Well, the other participants and the Mundanes also have self-preservation. And since the Masquerade limits escalation of conflicts, most of the time it allows everyone involved to co-exist with reasonable minimum of effort. So pretty much everyone's long term interest is to keep it quiet.

The less Hidden participants are capable of reliably identifying each other upon encounter, the more Fog of War Masquerade creates. This separates those who would be on each other's throats and also serves as a deterrent against escalation (and they can see how concealed weapons on small scale and nuclear submarines on large became extra deterrents in the mundane world): if you cannot be sure who, what and how many of them you would have too deal with, and what exactly they can do, it's another good reason to avoid a trouble. Both factors work better with many wildly different participants, since there are more things to miss or mix up. No one wants to give potential enemies an advantage, so every active participant helps to keep others in the dark; "leaks" happen, but cannot be easily validated, thus more often than not misinform.