How Does a Demat Account Work?

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Currently, a demat account is a mandatory requirement for buying and selling stocks in the Indian share market. This regulation was introduced by the Securities and Exchange Board of India (SEBI) to make stock trading easier and more hassle-free.

Before this mandatory regulation was introduced, traders and investors used to buy and sell physical shares in the stock exchange through the open outcry system. This required individuals to personally visit the stock exchange’s premises to carry out a purchase or sale transaction with other interested parties. However, this system was plagued with several issues like forging of physical share certificates, non adherence to contractual obligations, and more.

In a bid to eliminate all of these issues and disadvantages, SEBI introduced the concept of demat accounts in the late 1990s. And since then, the Indian stock market has radically changed for the better. Interested to know how a demat account works? Continue reading to find out all about this. And to make the concept easier to understand, let’s first take a look at what a demat account is.

What is a demat account?

A demat account is basically an electronic account that allows you to safely and securely store a wide range of securities in the digital form. With a demat account in your name, you can store securities like shares, bonds, mutual fund units, Exchange Traded Funds (ETFs), and more.

The account is protected using a user ID and password. This effectively prevents individuals other than the intended owner from gaining unauthorised access to the contents of the demat account.

So, to put it in simpler terms, the demat account is the stock market equivalent of a bank account. Just like how a bank account stores all of your money electronically, a demat account stores securities like stocks and bonds. And just like a bank account, you can also transfer the securities in one demat account to another account electronically.

How does a demat account work?

Okay, so now that you’re aware of what a demat account is, let’s take a closer look at how it works. A demat account holds the dematerialized version of your securities. And to ensure that the demat account works in a hassle-free manner and to facilitate the purchase and sale of securities seamlessly, it is usually linked with a trading account. A trading account allows you to buy and sell securities via an exchange. The securities that you buy through a trading account are then stored in the demat account.

That said, the linking of these two accounts is not mandatory. You can choose to hold a demat account separately without linking it to a trading account. However, buying and selling securities in the stock exchanges wouldn’t be possible. You can only hold your securities in a demat form, without the freedom to trade them. This is why it is essential to link your demat account with a trading account. 

What happens in your demat account during the purchase and the sale of securities?

Let’s say that you’ve linked your demat account with your trading account. Now, when you purchase shares in the stock market through your trading account, these shares that you’ve bought are credited directly to your demat account, where they are stored safely.

Similarly, when you sell the shares that you hold in your demat account through your trading account, the requisite number of shares that you sell will be debited from your demat account automatically.

This is precisely why many stock brokers choose to link both trading accounts and demat accounts together. As you can see from the above explanation, linking both of them together makes the entire process of stock trading seamless and hassle-free.

Working of a demat account: An example

Let’s now take up a couple of examples to better understand just how a demat account works. We’ll take up two scenarios – a purchase transaction and a sale transaction – to see what happens in the demat account in both scenarios.

What happens in your demat account when you purchase shares?

Say you’ve recently opened a demat account and linked it with a trading account. You wish to purchase 100 shares of Infosys Limited. And say the shares are currently trading at Rs. 1,900 per share.

After ensuring that the requisite amount to purchase these 100 shares is present in your trading account, you go ahead and place a buy order for 100 shares of Infosys Limited.

Once the buy order gets executed, the 100 shares that you bought will get automatically credited to your demat account within 2 days from the date of trade (T+2 days).

What happens in your demat account when you sell shares?

Continuing on from the example that we saw above, say the shares of Infosys Limited have now risen up to Rs. 2,000 per share. Therefore, you wish to sell the shares that are in your demat account for a profit.

And so, you place a sell order for 100 shares of Infosys Limited. Once the sell order gets executed, the 100 shares of Infosys Limited that you have in your demat account will be debited automatically at the end of the trading day. These shares will then be automatically credited to the demat account of the buyer within T+2 days.                 

What are the advantages of a demat account?

So, you now know how a demat account works. But dematerialization is not the only advantage that it offers. In fact, a demat account offers plenty of other benefits over physical share certificates. Here’s a closer look at these advantages.

1. Enhanced safety and security
   

   This is one of the most important advantages that a demat account offers. Since all of the securities that you hold are protected by a user ID and password, obtaining access to the contents of your demat account is virtually impossible. That’s not all. Since you hold and transfer the securities in a completely electronic format, there’s absolutely no scope for forging or faking the share certificates.
   

2. Enhanced convenience
   

   Before the demat account was introduced, individuals used to carry their share certificates personally to the stock exchange to sell them. This took up a lot of time and energy. However, all of that has now been eliminated with the introduction of the demat account. You can buy and sell shares over the internet from the comfort of your own home.
   

3. Speeds up the stock trading process
   

   Thanks to the demat account, a stock trade now takes less than a minute, which was not the case when physical share certificates were still in use. Back then, it used to take up to a week or more for a trade to be executed completely. But now, it takes only a couple of clicks and a few seconds for a trade to get executed.
   

4. Eliminates risks associated with physical share certificates
   

   With physical share certificates, there were plenty of risks that you had to account for. Loss, theft, and damage being a few of them. However, with a demat account, all of those risks are eliminated since you store your securities in the electronic format.
   

5. Lowers costs
   

   One of the major costs that traders and investors had to account for with physical share certificates was the stamp duty. It was so significant that it used to increase the cost of ownership. With a demat account, the stamp duty rate is now very affordable, leading to lower costs.
   

6. Easy to keep track
   

   All that you would need to do to keep track of your securities is log into your demat account using the user ID and password given to you. You can get a complete overview of your investments from almost anywhere in the world at any time.
   

Conclusion

With this, we hope you’ve now gotten a good understanding of how the demat account actually works. The demat account, with all of its advantages, has completely revolutionised the way stocks and other securities are traded in India. It has not only eliminated any barriers to entry, but has also increased the participation of individuals in stock trading.

If you are planning on investing in the stock markets or trading in any securities, you can get started by opening a demat and trading account on TradeSmart Online. The demat account opening process is easy and paperless.