Sarok the Shady Dwarf is located within The Dugout, up in the North. You find him not much after entering these mines. (Spoilery Screenshot)

Sarok mentions a powerful item that he's looking for and offers you something in return.

This is the item he's looking for. Just keep track of things you loot after obviously important fights.

If you give him the item, you have two choices:

• Spinechiller: A sword
  
  
  
• Hatred: A staff
  

You get additional XP if you go on with the exchange. (5500 on normal)

However, you can also refuse to give him anything and fight him... Which will give you the two weapons but no XP.

Here are the weapon specifications.

Spinechiller:



Hatred:

Basically which option you want depends on how you built your characters.

Enjoy.