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This paper presents an embedded digital system for incremental encoders allowing for high dynamic performance and accuracy speed measurement in all the operating conditions for the application in digital servo drives. The idea aims at embedding processing capabilities inside traditional position transducers in order to develop a smart measuring system. The base processing algorithm employs a novel mixed time and frequency measurement technique of the encoder signals. The iterative formulation of the algorithm and the limited hardware requirements allows its implementation by means of a standard microcontroller (e.g., TMS320F24x) or by dedicated hardware. Communication between the smart sensor and the servo drive is preliminarily realized via high-speed serial peripheral interface.