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Over the past few years there has been tremendous interest in and adoption of dematerialization, aka the digitization of physical paper. Key adopters include the paper-intensive financial services and insurance industries, as well as all flavors of governmental agencies across the world.

Not too hard to figure out why. At its simplest level, dematerialization makes good business sense and good environmental sense for all kinds and sizes of organizations. 

While numerous factors are shaping the dematerialization space, here are the key ones:

·         The quest for the paperless work space is as strong as ever;

·         The drive to find a viable alternative to paper drives organizations to methods of securing and tamper-proofing electronic data;

·         Regulatory and compliance issues mandate super-efficient bookkeeping and recordkeeping; and, of course,

·         Everybody wants to cut, if not eliminate the escalating costs of storing paper -- while striving to be a good ‘green’ citizen.

The financial services and insurance industries have been using dematerialization for a number of years. These industries leverage dematerialization for electronic recordkeeping, which makes it easy to keep track of all kinds of financial transactions. 

One of the big advantages of such electronic bookkeeping is that organizations no longer need to physically store copies of balance sheets and other accounting documents. Thanks to scanning technology, organizations can make electronic copies of documents that provide references for line items in the electronic accounting records. Everything can be easily stored on a hard drive or server. 

Besides processing basic accounting records, dematerialization also makes it possible to do away with physical stock certificates. Electronic copies of stocks can be quickly made and archived for efficient retrieval and transmission.

Today, most U.S. securities, including municipal and corporate bonds, U.S. government and mortgage-backed securities, commercial paper and mutual funds, are offered in paperless form, according to the US-based Depository Trust & Clearing Corporation (DTCC).

However, “certain asset classes are lagging, of which equities is the most significant, noted the DTCC in its July 2012 white paper, “A proposal to fully dematerialize physical securities, eliminating the costs and risks they incur.” 

“Now, the industry has reached a tipping point, making it essential to push forward to full dematerialization,” added the DTCC white paper. 

“Thanks to the success of ongoing dematerialization efforts (measured by an 86% drop in the number of physical certificates held in DTCC’s vault since the year 2000), the economies of scale for physical processing have been reversed: the fixed costs incurred to support physical certificate processing are being recovered through a dwindling number of transactions. 

That means, as the number of physical issuances and transactions declines, the unit cost of processing them rises. Yet until the U.S. markets are fully dematerialized, the industry will be obliged to support this fixed-cost structure for physical processing regardless of the volume of certificates processed.”

Until recently, solutions for dematerialization lacked rock-solid, secure technology -- especially at the signature or data stamping layer. The technology at the heart of the signature or stamping layer must be able to date-stamp data, verifying its authenticity.

The concept of a digital signature for electronic data is very straightforward: a cryptographic algorithm is run on the data, generating a tag or ‘signature’ for the data that can later be used to make certain assertions such as signing time, signing entity and data integrity.

Historically, Public Key Infrastructure (PKI) digital signatures/timestamps have been used for this purpose –however, the complexities and cost of key management make it very challenging to scale. 

A new, alternative solution to PKI is Keyless Signature Infrastructure (KSI). The main innovations of KSI are its distributed delivery infrastructure enabling it to scale, and the removal of the reliance on cryptographic keys for signature verification.

KSI uses hash-linking digital data authentication and hash function server-side signatures to assert signing time, signing entity and data integrity. Without the complexities of key management it is possible to easily deploy on a very large scale. 

The assertions on time and integrity are based on the reliability of electronic or print media --i.e. they can be made independently from the service provider. The assertions around signing entity are based on the service provider acting as a trust authority.

PKI and KSI are entirely complementary technologies. For example, in Estonia (the birthplace of KSI and the only country whose government has broadly adopted PKI) PKI is used for legally binding electronic signatures, while KSI is used to prove that the signing key was valid at the time of signature and to verify the general signing of machine-generated data such as system logs and banking transactions.

Clearly, the best days of dematerialization lie ahead. The signs of the future are plentiful: most organizations which have already experienced the merits of digitizing paper have incorporated dematerialization into their psyches; there’s an insatiable appetite in organizations to replace paper records; and, last but not least, KSI technology is setting a new standard for excellence in data authentication.

About the Author

Mike Gault is CEO of Guardtime, a developer of digital signatures that algorithmically prove the time, origin and integrity of electronic data.  He started his career conducting research in Japan on the computer simulation of quantum effect transistors. He then spent 10 years doing quantitative financial modeling and trading financial derivatives at Credit Suisse and Barclays Capital. Mike received a Ph.D. in Electronic Engineering from the University of Wales and an MBA from the Kellogg-HKUST Executive MBA Program in Hong Kong. You can reach him at Mike.Gault@guardtime.com or visit www.guardtime.com.