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An item's quality determines its effectiveness and how long it will last before breaking. Weapons of higher quality deal more damage and tools of higher quality perform their function quicker, i.e. do higher block damage [No longer seems to be the case in A17. Is this a bug?].
Item quality is indicated by both a color-code for quick reference and a numerical value as a precise measure of quality, displayed beneath the item's icon in the Inventory. The measure for quality ranges from 1 - 6:
Madmole has suggested that Alpha 17 will feature legendary quality weapons that can only attained as rare loot with unique stats and buffs.