I shared some information about this in https://discuss.flarum.org/d/31880-incorrect-ukrainian-slug-transliteration/2
The setting determines how discussion URLs are generated. Both of the built-in drivers use the discussion ID and add a user-friendly "slug" part for SEO purpose.
In short, the difference between the two is that default (or empty) generates a slug using only alpha-numerical characters ("ASCII") by transliterating non-ASCII characters to ASCII equivalents. utf8 only strips spaces to create a slug while keeping most special characters. Those characters might be displayed in their encoded form by some browsers.
Extensions are able to provide more options.
