The dream sequence is one of those perennial media techniques that creators seem to think doesn't look as lazy to consumers as it actually is. They're wrong, of course, and most savvy audience members are able to spot the fake-out a mile off. This isn't to say that they can't be artfully created, or cleverly integrated into the texture of the plot, just that as a general rule they aren't. I'd blame magic realism except I like it too much to do so, but I suspect that at least part of the problem is that more conventionally structured works often look upon its techniques with a hungry eye and a lack of understanding. Sharks attracted by the scent of bloody metaphor leaking into the fathomless ocean of prose.
In general, a dream sequence doesn't have to signify mental unrest or madness. Yet one of the primary cinematic languages of dreams is derived in main from the techniques of portraying visually a disturbed mind, first delineated in The Cabinet of Doctor Caligari with it's unnatural camera angles and impossible geometries. In turn this has further informed cultural constructions of madness, which already had a reputation for being a dream-like state in which the mad were trapped and unable to awake, generating an idea of madness as a predominantly visual, or at least sensual, experience. Still, in the majority of fictional forms dreams have for a much longer time been a place of revelation - a way of advancing the plot by disguising exposition as mystical insight. And then disguising it further by making it all rather symbolic.
This needs to be handled with care of course; as with anything which takes agency away from characters it can end up stopping you from caring about those characters. The single worst plotline it is possible to write is the one which starts with the protagonist having a dream compelling them to action and ends in a deus ex machina*. But, we can't argue too much with the classics, because really vision quests are as old as religion and they're not really what I wanted to look at here.
Within games you do get the occasional bit of expositionary dreaming, but in many ways this is just another flavour of the endless task of getting the player(s) on to the next bit of action. As with all cut scenes, flavour text or DM rail-roading it can be done in a more or less satisfactory way, but it lies firmly within the imposed narration of the game rather than the shared space created during play. What I'm more interested in just now is something that is unique to the way games work, and how this affects depictions of dream worlds.
Games are heavily predicated on player agency. I know that there are arguments about how much agency players actually have (especially in video games where there are technical limits imposed on action) or should have (in the case of heavily narrative games), but there are very few games which still manage to be games and don't at least allow the player some choice over what to do. Dreams, on the other hand are most notable for the lack of agency we experience when we are caught up in them. It's true that some people claim to be able to lucid dream** but they're basically just a bit better at having fantasies than the rest of us in my opinion.
That's not everyone's opinion though, and there is a strong faction arguing that the dream-world is a real place, or semi-real, or something coherent at least; a place where actions can have consequences, where rules, even if not the normal rules, can apply and where, just maybe, causes can have effects outside of the dream itself. The mechanism of this might be one of many; the dream being part of the larger spirit world is the classic model, but Freudian, and then Jungian, psychoanalysis has added a version with the veneer of scientific respectability to the lexicon, however unwarranted that respectability may be.
the Psychoanalytic model is worth studying here for another reason, namely to start answering the question you may have been asking; why are we talking about dreams in a blog interested in mental illness? the short answer is that a common misconception about madness, and a common depiction of it (as hinted at earlier), is that it is a waking dream. The experience of madness is often equated with that of dreaming, focusing on the supposed lack of structure and causality experienced in the two states. This is despite the fact that in madness if anything is irrational it is the subject while in a dream irrationality lies within the objects and surroundings. Psychoanalysis only compounds this by suggesting that the contents of dreams are important signifiers of waking dysfunction, and that the key to treating and healing that dysfunction can be found within those dreams.
Madness is constructed as being trapped in the dream, then, and clearly something must be trapping us, either an external force or an aspect of ourselves. Well, if there is something trapping us then clearly we need to face it and defeat it, for the alternative is either coma and death or, well, madness. Or at least such a perfect facsimile of madness that to an external observer there is no need to distinguish and the one can quietly replace the other. This is an important point about cultural constructions of madness, actually, as it is one of the mechanisms by which the mad can be blamed for being mad: it may not be their fault for being trapped in the dream, or the spirit world or whatever, but it is if they lack the strength to escape; in fact it's just the old willpower 'try not being depressed' canard but with a spiritualist or psychoanalytic flavour depending on taste.
Hence, the video game playable dream sequence, where the protagonist journeys to the centre if their dream and slays the evil that lurks their using the exact same moveset they posess in the waking world. I hate playable dream sequences***. In addition to the sense that you achieve nothing, because it's a step removed even from the game world, I've always felt that dream sequences really highlight the lack of options available to the player as well as the limits of the technology representing those options. It's all very well to tell me that I'm in an imaginary space where anything can happen, where the rules are different and dream logic applies, but when that resolves down to the same gameplay as every other segment then it's hard to maintain any suspension of disbelief.
Oh, how do I hate you? let me list the ways. [Spoilers]. The big daddy of them all has to be Dragon Age: Origins, purely for length. You fall asleep and navigate the fade, which is an extended sequence of door based puzzles and smashing things with your sword. Bonus points go for meeting people in the fade who have given up because they aren't strong enough - those guys need to buck up yeah? We all have problems. The thing I found really odd about this section is that it hints that in the fade willpower is important, much more so than physical strength, but all challenges were still resolved with the same stats as before. There was such scope for making the mage of the party a badass while turning the fighter into a wimp, but it was completely ignored. The rules are completely different, and yet somehow completely the same.
The two Batman Arkham games have dream sequences as well, as you might expect in a game heavily invested in concepts of madness and institutionalisation. When Scarecrow gets to you in Arkham Asylum the whole world collapses into a morass of shifting geography which has the potential to be much more than it is. I can buy the idea that Batman has just the right tools to traverse the physical locations in Arkham, part of Batman's legend is that he is always prepared, even down to carrying shark repellent bat-spray, but the idea that Scarecrow creates a shattered mental geography that is yet designed for the same tools again felt like a disappointment. Not to mention the skeleton warriors who act suspiciously like the thugs in the rest of the game (although it is suggested in the final sequence that Batman is actually fighting inmates, I don't recall that in the previous segments). The one good thing I do have to say about those sequences is the way Batman defeats Scarecrow is to my mind perfect: by shining the bat-signal in his face, effectively asserting his own madness over that of the Scarecrow’s.
I didn't get too far into American McGee's Alice when I did play it, but as a game which takes place entirely within the mind of its protagonist I think it highlights a lot of the problems I've discussed. It repeatedly tries to tell you that the world is shifting, illogical and doesn't make sense, and yet it has to make sense in order to be playable. In fact, it makes the exact same boring, linear sense as any other FPS, being a series of combats linked by corridors. That these corridors look different is no matter, because they function exactly the same as any other game's.
I could go on, or cite more examples, but really I think that's the crux of my point: this isn't a dream, and this isn't madness, it's just a palette swap, a different location. to my mind, the best dream worlds in games are not the ones which try to be about the look of the world, but the ones which use it for narrative power instead. The Legend of Zelda: Link's Awakening springs immediately to mind here. Yes, he defeats the evil at the centre of the dream by hitting it with a sword, but the strangeness of the dream itself is revealed slowly, not hammered down your throat. It is also, notably, a story about self discovery rather than one about the oppression of the mind. And I crucially think that that is the most important step to making dreams fun again, and rescuing them from Freud's pathologising; dreaming is ultimately part of our mental processes for understanding the world, not a hidden well of all the worst things that have ever happened to us. they can be fun or they can be horrible or they can be just weird, but they are natural, and that is the most important thing.
*And then they wake up and it was all a dream anyway.
**I once made myself have the same dream two nights in a row, I died at the end both times and woke up shattered so I don't really know why I bothered.
*** I love a good narrative dream sequence though, I'm not going to lie. Inception, for instance, is a thoroughly stupid but beautiful movie.