What is Dematerialization?
In finance, dematerialization refers to the transition from physical paper-based stock certificates to electronic bookkeeping.
- Dematerialization refers to the transition from physical paper-based stock certificates to electronic bookkeeping.
- With technological advancement and the increased sophistication of computers in the last few decades, dematerialization became a major trend beginning in the 1960s.
- Four of the major benefits of dematerialization include safety, convenience, cost efficiency, and flexibility, making investing significantly easier for investors, especially individuals and small-time investors.
Historical Background on Stock Certificates and Dematerialization
Paper stock certificates were popular in past centuries as a method of providing shareholders with tangible reminders of their ownership in companies, and as such, they were often ornately engraved and elaborately designed. The designs functioned not only as a form of marketing but were also an effort to dissuade fraudsters from making forgeries.
Stock certificates would also provide important information such as the number of shares owned, serial numbers, and a company seal with the signature of senior executives and directors.
However, with technological advancements and the increased sophistication of computers in the last few decades, dematerialization has become a major initiative since the 1960s, with companies moving from producing hard-copy certificates to registering and transferring electronically.
The transition towards dematerialization enabled not only the elimination of a cumbersome paper-based method of recording stock exchange transactions but also allowed accounts to be updated automatically through electronic bookkeeping.
Dematerialization is beneficial for investors, brokers, and companies. For investors, dematerialization reduces the risk of holding shares in a paper-based physical format and results in reduced brokerage fees and postage for transferring share ownership. For brokers, it reduces the risks of delayed transactions, which enhances profits.
For companies that issue stock certificates for their shareholders, dematerialization means that they can save significant amounts of money related to the printing and distribution of physical stock certificates. Efficiency and timeliness are greatly increased as a result of dematerialization and ensures that liquidity becomes much higher since the entire process is automated.
We will now go over in more detail the four major benefits of dematerialization – safety, convenience, cost efficiency, and flexibility.
Safety was greatly enhanced with the conversion of physical certificates into electronic shares since dematerialization eliminated the possibility that shares would get lost or misplaced by individuals or traders.
The risk of fraud and theft was also greatly reduced and no longer required investors to keep their physical share certificates locked up in their safes and safety deposit boxes along with their important documents and jewelry.
Convenience was also an important benefit of dematerialization since the lengthy transfer of shares from one owner or institution to another usually took weeks or even months to manage, especially for parties located in different countries.
Even transfers between domestic parties would take a long time since investors needed to send the physical certificates back to the issuing companies to get the names of the owners changed on the certificate before it could be sent to the new investor. It was an extremely tedious process, which was eliminated entirely with dematerialization.
Today, shares can be transferred easily, and the entire process only takes a couple of days. In previous eras, even moving residences was a serious issue where physical stock certificates were concerned. Investors who moved to a new address, town, or country needed to fill out an application and send it to the companies requesting a change of address for all the correspondence. Dematerialization eliminated that tedious process as well, and now, a simple address change can be easily updated in the company’s electronic records.
3. Cost Efficiency
Cost efficiency was also enabled with dematerialization since the electronic trading of stocks no longer requires cumbersome paperwork, which inevitably leads to a lot of administrative expenses, such as postage fees and an abundance of secretarial staff.
4. Increased Flexibility
Increased flexibility for investors was another benefit of dematerialization, which improved access to investment for smaller investors and individuals. In the past, shares were usually traded in lots, which would’ve been unaffordable for small-time investors.
However, with the introduction of dematerialization, one can buy and sell single shares or several shares without facing any significant financial hardships.
Another concept closely related to dematerialization is rematerialization, which is the exact opposite of dematerialization. Rematerialization refers to the transition of shares from electronic form back to a physical form, but it occurs much more rarely in comparison to dematerialization. Rematerialization occurs much less frequently because of the increased risks of theft and forgeries related to physical stock certificates.
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