Digital phase demodulation is being developed as a flexible heterodyne demodulation technique for on-line dynamic displacement detection. The digitized modulated carrier and reference carrier signals from a heterodyne interferometer are demodulated for surface displacements using computer algorithms. Since the signal demodulation is performed in the computer, the heterodyne beat frequency or center frequency of the carrier signals can be easily optimized for the desired detection center frequency and the heterodyne beat frequency does not have to be stable. The resulting measured displacements are calibrated with respect to the wavelength of light used in the interferometer and remain accurate for displacements larger than the wavelength of light. No assumptions are made about the sideband frequency content or the amplitude of the surface displacements. The research presented here introduces digital phase demodulation concepts and shows initial experimental results from a heterodyne interferometer while monitoring vibrational and ultrasonic displacements. The initial results show that the heterodyne sensor system is capable of measuring displacements greater than three wavelengths of light and has a single-shot resolution better than 7 nm. Thus digital phase demodulation will allow a single instrument to monitor displacements produced by low-amplitude, high-frequency ultrasound and by high-amplitude, low-frequency vibrations.