It's either a game, or an interactive "choose your own" comic. If I go for the comic it will be a sprite comic, since I've already sprited the characters and sprites are just more fun to work with for me.
Anyway. Nightmare Dreams is about you as you journey through some sort of weird dream world where anything is possible. The gameplay to be honest is similar to Knights of the old Republic II, in the sense that almost everything you do will change your allies.
Unlike KotoR II The changes are not good or evil. While everyone has a Good/Evil metre, it isn't the only thing that will change.. You will also change their Dream/Nightmare metre. Your own Dream/Nightmare metre changes based on where you are, if you are in a recreation of heaven, you'll be closer to dream, if you are in a swamp surrounded by skeletons and deformed corpses, alot of nightmare.
Unlike Kotor II you never see your own character, instead controlling your own team of friends. You will still interact with people as if you are there, but as far as the screen shows, you are invisible, or not there at all.
Here's a random example-
You and two friends are travelling through a forest. One is good and one is evil. You find a rabbit. The evil one will want you to kill it for no reason, the good one will not. You choose which one to listen to, (but instead of you killing it, since you have no affect on the physical world, the evil character does it for you). The good character will get angry with you and move towards good out of mercy for the rabbit but nightmare after seeing it die.
However, nightmare doesn't mean they dislike it. For instance, killing the rabbit is a gruesome act and can move the evil character towards nightmare, even if he enjoys it.
Nightmare is things like death, blood, gore, pain, lack of mercy, nightmare and evil are linked heavily in this regard. However, a good character can still stay good and move towards nightmare, AND still like the player. Though it's still rare to do so.
Dream acts are things that anyone enjoys. Love is a dream thing, flowers, though good and dream are still more likely to work together. Since kindness is a very dreamlike thing.
Of course. You could try to get all the characters to like you, but since all of them are following your orders at once, it is inevitable that alot of them will dislike you. (Though it's probably possible to split them up, so if you were clever about it...)
Another thing that you must remember is that ALL characters have different personallities, one evil character might like different things to another evil character. And that personallity (along withe their alignment) will change dramatically after you "lock" them in nightmare or dream form. Here is a list of currently sprited characters.

In order from top to bottom-
Steel
The first companion. A robot designed to help dream-land visitors. He acts as a tutorial for the first part of the game. As a robot, he is the strongest character in the game and can lift heavy objects. Personallity wise, he is neither good nor evil, instead he does what makes the most sense at that time, but it takes acts of pure stupidity or risk to make him dislike the player.
Dream form- Nothing changes. He acts the same and the only change is that his "mouth" gets smaller.
Nightmare form- He turns into some kind of disturbed skeleton-based robot with creepy eyes and a ribcage design. He grows a hatred for humans.
(Unnamed at this point)
A blind teenager, he doesn't seem to be from the dream-realm as the other dream-characters are much more strange. Though he is blind, he can sense things that other characters could not. Personallity wise he's very quiet and has a strong sense of justice, but hates it when anyone and anything gets away with a crime. He is slightly good.
Dream form- His hood is replaced with a hat and he wears it up to reveal more of his head, he also does his jacket up, giving him a priest-like appearance. He's a little less shy and openly tells the player of his origins and that he doesn't want to go back to the "real world".
Nightmrae form- He wears his hood even lower and his jacket is apparantly longer. He no longer talks at all. Any attempts to communicate are answered with a blunt "...". He now treats the player like a god and aks for permission to kill anyone who disobeys him.
Myst
Myst is a creature born of the players imagination, hence why he is formless (as the player is supposedly formless in this world). Myst has no personallity and agrees completely with everything the player says or does. Whereas the player moves towards nightmare or dream depending on the area he is in, Mist moves towards nightmare or dream based on the actions the player has done. Referred to as a He right now since it's easier. Even though Myst is of the players imagination, characters seem to acknowledge it's existance, and Myst is required for the later stages of the game.
Dream form- He gets a single line on his face and his body seperates into three pieces, making him seem slightly more humanoid. Personallity wise he expresses emotion, but retains the same "yes sir" personallity as before.
Nightmare form- Myst looses all resemblance of anything human or even physically possible, due to the player's clear insanity. Myst now speaks in confusing paradoxes, as if he himself as gone insane.
Muffer
Muffer is a being of the Bliss part of the Dream world, but got lost in a nightmare swamp when the player finds him. Muffer is a silly clumsy fool. His greatest treasure is his ears. He can smell treasure from miles away and will inform the player when he's found something. Personallity wise he's very lazy and generally is happy with the player if he is happy, though he hates it when the player is mean for no reason. He frequently complains about the shortness of his ears.
Dream form- His ears have increased in length dramatically. Personallity wise he seems much prouder and constantly complements himself.
Nightmare form- His ears have been brutally cut off, leaving nothing but scars. Muffer is incredibly traumatized and will only whimper quietly to himself. He opens his eyes due to shock and fear.
Torment
Torment is born in the same way as Mist. It is possible to get him twice in the game though getting him the first time will cancel out the second chance, to unlock him you must kill a certain character, both chances the victim is traumatised enough to create Torment before they die. If you are going for a pure Dream game, he won't be seen at all. Personallity wise, Torment doesn't express emotion and will normally be the first to tell you to kill something, even if he won't do it himself. The mark on his chest is actually a stab wound as a reminder of how his creator died.
Dream form- If Torment goes far enough down the dream path he will abandon you.
Nightmare form- Torment gets a taste of his own name. The apparant stab wound on the chest now bleeds openly and his eyes and face are in a perminant state of fear and shock. He now screams at random points and sometimes complains about "the pain" when walking or standing around for too long.
Clown
Clown is a bit odd. Creepy if you stare too long, but after meeting him he's not very mean. He used to be a jester for the dream part of the dream-realm so he's clearly a nice guy. He has the ability to juggle items, allowing you to hold up to three extra items at the cost of Clown having to stand still to juggle. Personallity wise he is clearly insane, but he knows it and he's nice about it. He's a moral person but will accept any evil deeds if they appear to be pranks, or just look funny.
Dream form- He looses his insanity and along with it, his clown gear. He's still stuck with a perminant smile and a big white bald head. But now he's calmed down a bit. He now acts like a regular little boy.
Nightmare form- Clown is already insane, but nightmare just pushes him over that tiny bit further, turning him into a "monster clown". He also treats the player as the master of the group and always calls him as such. His insanity also causes him to threaten to kill things and laugh like a maniac whenever he is allowed to.
I think I forgot to mention the good/evil alignment on some of them, but it's probably obvious. I think I need more good and less evil, don't you agree?
Obviously, anyone going for nightmare will see alot of disturbing stuff as the dream-world changes around them. And anyone going for dream will see strange and wonderful places. Anyone in-between, a bit of both. "Locking" a character in Dream form or Nightmare form acts as a quest, so you'll have to do certain objectives once they reach the correct alignment. And obviously, doing so will earn alot of good or alot of evil points.
It is possible to bring all your friends into the dream forms and still be evil, and it is possible to bring all your friends into nightmare form and still be good. But if you are really a good guy or bad guy, why would you want to?
Anyway that's all I've got so far. There's also a transport that is undecided so far, that allows you to travel from place to place, maybe the transport changes depending on you or your characters current situation, I dunno.
This is just an idea. So don't expect me to take this anywhere just yet. Though I really would love to.
EDIT: Aw crap the image got shrunk. Hold on..
EDIT2: I made it bigger so it's easier to see. So maybe having these sprites at normal size is somewhat of a downside.