In a foreboding laboratory within the metallic compounds of a secret base, Doctor Ivo "Eggman" Robotnik finishes his final preparations to his latest contraption, hooked up to a mysterious ring-like artifact and a pod containing a sleeping Cream the Rabbit and her pet Chao, Cheese. Donning a brain-activity headset also linked to his new machine, Eggman initiates his latest plot to achieve world domination, but is suddenly confronted by a mysterious voice who calls him out for using a child to further his plans. All of a sudden, the mad doctor gets knocked out, though he manages to let out one more sinister chuckle.
Much later, a couple of intruders break into the base and the lab where Eggman, Cheese, and Cream were sleeping in. This group consists of Sonic the Hedgehog, the world's fastest thing alive, Miles "Tails" Prower, Sonic's genius twin-tailed sidekick, Knuckles the Echidna, the last living member of the Echidna Clan and guardian of the legendary Master Emerald, Amy Rose, Sonic's self-professed girlfriend, and Rouge the Bat, a treasure hunter who got intel about Eggman's newest base for a bounty. Amy and Tails try to free Cream and Cheese from their pod, to which Tails muses about Eggman using her as a "filter" for the artifact which had the power to control dreams. All of a sudden, the whole team gets knocked out, falling asleep and falling into a dream-like portal soon after, just like Eggman.
Sonic awakens in a cavern in a strange new environment, commenting on the bizarreness of literally "falling asleep". Suddenly, the same mysterious voice which confronted Eggman tells Sonic to move forward while reassuring him that it is taking care of his friends. Seeing the only option is to trust the voice, Sonic presses on through the new realm, speeding to the end of the road where a magical orb and a portal await him. Upon entering the portal, he enters a subspace where meets the owner of the voice, who turns out to be a benevolent sheep-like creature named Ariem, the guardian and Dreamweaver of the Reverie. Ariem tells the blue blur that she needs his heroism to reclaim the magical spheres called Dream Orbs to stop Eggman and free the Dreamscape from his nefarious clutches. Sonic hands over his recently reclaimed Dream Orb to Ariem, who uses it to free Amy from her Dreamscape. However, that is all Ariem can do for the time being; she is not powerful enough to free everyone else, though she has tried to explain their situation to the others, with Tails noting that they cannot break out from their own Dreamscapes even though they can talk to their freed companions. Ariem explains that with enough Dream Orbs, she can free the whole team, but thanks to getting separated from a bigger orb of light called the Dream Core, she cannot wake them up. Acknowledging the situation, Sonic and Amy begin the work to recover all the Dream Orbs they can reclaim.
Sonic and Amy venture through the realm to reclaim the Dream Orbs, tearing through Eggman's forces along the way and allowing Ariem to help them venture deeper into the Dreamscape. Tails notes of the tight security Eggman developed within the Dreamscapes, forcing Sonic and his team to rip them apart to enter other Dreamscapes and help Ariem gain enough power to free Tails and Cream. Along the way, they learn about the Reverie: this ring-like artifact can grant any dream its users wish for, but only if they are "pure hearted". Doctor Eggman, who is anything but pure, kidnapped Cream and Cheese to filter his vile, selfish ambitions through their sweet, innocent minds. Ariem managed to lock him within his own Dreamscape, but laments about not being decisive enough to completely foil his plan. With that information, Tails notes that Ariem authorizes noble dreams and Eggman would potentially find a way to force her to grant his own wicked dream. After freeing Tails and Cream, the team also learn of Magination, a liquid dream essence fuelling each and every dream of its users, also noting that Eggman managed to corrupt a portion of it to power his own machines. They also discover Eggman planning to create a beast using the corrupted essence. Depending on the players' choice, Tails or Cream try to stop him, but Eggman's foremen robots manage to stall them long enough for the mad doctor to complete the rabid beast's final touches.
Despite Tails or Cream's defeat, Ariem has enough Dream Orbs to power herself again, freeing Rouge and Knuckles. As the two begin aiding Ariem, Tails runs an observation of the Reverie, stumbling across a "Dormancy" protocol. Ariem explains that this protocol shuts down the artifact for a thousand years should the ring fall into the hands of diabolical dreamers, purging the Reverie from their influence. This requires Ariem to be at full strength, which she has not yet achieved. However, as soon as Sonic's team rendezvous with one another, the beast, only known as the Guardian Hunter, strikes Ariem, leaving her wounded. Enraged by this underhanded attack, Knuckles or Rouge (depending on the player's choice) confront and defeat the nightmarish monster. However, the damage is done, and Ariem is drained of power, something that not even the Dream Orbs can help her recover from.
Sonic and company enter one last Dreamscape. This realm, Ego City, is based on Eggman's empire, which Tails deduces is what Eggman intends to bring to the real world and achieve his goals in one fell swoop. The team barges through the corrupted realm to collect the last of the Dream Orbs, but run into one last barrier from Eggman. Ariem offers up the last of her power to break it down, turning into an orb herself. All are saddened by Ariem's sacrifice, but Knuckles leads the gang to settle the score with Eggman, stepping first into the twisted construct of Eggman's Dreamscape to free the locked down Dream Core.
On the other side of the portal, Eggman is already waiting for Sonic and his team to give him Ariem. He sadistically boasts of having control of his dreams, gloating about having already claimed victory over everyone. Cream, however, is undeterred by the doctor's taunts, which Eggman rewards by sending a giant construct of his arm to pulverize the ground beneath Sonic and his team, separating all of them. Tails quickly formulates a plan: he will work on unlocking the Dream Core's container while everyone else distracts Eggman and pass on Ariem's orb to one another. The team quickly set their plan in motion, dodging and evading Eggman's relentless attacks, but Eggman pushes them all away from the core just as everyone arrives at its podium. This action came into too late, however, as the casing is open for Sonic to hurry over and throw Ariem into the core, restoring not just her physical body, but also her full strength. The dreamweaving guardian quickly expels Eggman from the Reverie before shutting it down for a thousand years, allowing all of the heroes to return from their sleep.
Sonic and company wake up, all still in Eggman's lab, while Tails frees Cream and Cheese from their pod. Rouge notes of the Reverie being inactive, to which Tails reveals he managed to work on the ring's failsafe to allow them to freely visit it and Ariem for a short period of time. A defeated Eggman lets them take the Reverie, but not before vowing to ensure his dream of world domination finally comes true. Unimpressed by Eggman's twisted resolve, Cream orders Cheese to "knock the mad scientist cold", via reactivating the Dream Machine to put him back to sleep, as payback for his torment before leaving with everyone.
Much later, Tails finishes working on the Reverie to allow Cream to visit its environment again. Ariem warmly welcomes Cream back, noting of Tails' intellectual genius in the process.
