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I have a DSL modem, a router, and a Windows machine. Each piece of equipment can set the DNS server IP addresses or be set to automatic. Where/how should the DNS servers be set for best performance?

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For best flexibility I'd vote for the router. He's that part of your equipment that sees both worlds: The Internet and your "Intranet". This way you don't have to worry if you connect further devices in your network (maybe a tablet PC, a smartphone or a second computer - maybe a friend will eventually come to your place with his Laptop).

Also most routers offer to manage a host list of your devices connected to the private network, so you don't have to maintain a hosts file on each device seperately.

Generally you shouldn't worry about performance when it comes to a private DNS caching server - what you should worry about is availability - which device is reachable by all my equipment and which device is most unlikely to be turned off when I want to connect to the Internet?

Performance issues come to mind if several hundred clients have to be served.

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The DSL modem should grab the DNS settings for you. Then have the router just hand those settings out. On such a small network, there will be no difference.

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Use Google's Nameservers!

They are distributed all over the world (BGP Anycast) and are uncensored and fast!

DE => ;; Query time: 58 msec
GB => ;; Query time: 44 msec
JP => ;; Query time: 49 msec
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Any data regarding "fast"? – Hello71 Oct 16 '11 at 15:22
just did those a few sec ago on a domain of mine via dig mydomain @ on various CDN-boxes of mine. – Franz Bettag Oct 16 '11 at 15:36
Versus other nameservers? – Hello71 Oct 16 '11 at 15:39
This sort of suggestion is sometimes made by people unaware of the consequences of trusting someone that one has no contractual relationship with for proxy DNS service. Using someone else's proxy DNS service is risky. It can allow that person to subvert all sorts of things, including things that one might think to be secure. It's not something to blithely do on the simple recommendation on WWW sites of random people that one doesn't know. "Where do you think will go, today?" – JdeBP Oct 16 '11 at 16:01
You are stating that people should use them. You do so in the first three words of that answer. Stop trying to misrepresent yourself. This isn't religion. This is about dopey recommendations made off the cuff, like yours here, to do things that are risky. – JdeBP Oct 17 '11 at 7:11

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