As with many derivatives, one can choose to cash or physically settle the trade.

In the event of default in cash settlement.

The loss on the bond from par, that is one minus the recovery rate multiplied by the notional, is paid in cash to the buyer.

In physical settlement, the buyer delivers the reference bond to which the CDS relates in exchange for the full notional of the CDS contract.

The question is if there's any economic difference between the two settlement methods and the answer as it normally is in these situations is no, not really.

If we use the example where the notional is 10 million and the recovery is 40% in the cash settled case, the cash payment will be 6 million.

In physical settlement, the exchange will be 10 million in cash versus a bond worth 4 million, so a net value of 6 million in practice, the settlement style chosen will be the one deemed most convenient by the counterparties traders who are using the CDS to generate p and l will tend to prefer cash settlement, whereas those who are using it as a hedge to an underlying bond position will probably prefer physical.