http://lewrockwell.com, by Paul Wheaton
When sprinkled on a bug that has an exoskeleton (such as bed bugs, ants or fleas) it gets caught between their little exoskeleton joints. As they move, the diatomaceous earth acts like razor blades and cuts them up. But it doesn't hurt mammals. We can eat it. We do eat it! It's in lots of grain based foods because lots of grains are stored with diatomaceous earth to keep the bugs from eating the grain!
I have heard two explanations of how diatomaceous earth works.
One is that on a microscopic level, the diatomaceous earth particles are very sharp looking. These particles stick to an insect and get stuck between its exoskeleton joints. As the insect moves, it gets physically cut up.
The other explanation is that diatomaceous earth sticks to the insect and somehow causes them to dry out. I think this approach involves scratching the insects waxy layer which then allows precious moisture within the insect to get out. So their teeny tiny bug-innards turn into teeny tiny bug-innards-jerky.