The initial part is a dream sequence yes, the current part? It's real. The fact you might be confused and uncertain (especially with the dream you did just have) is very much intended. As mentioned, a running theme with these battles is that you're inside of someone's "Fantasy" and of course everything is inherently unreal. Most people would just quickly assume this is all a dream and go with the flow, which is why they're puppets. You all have the opportunity to take control of your own actions, or you could just become puppets.

In which case I just take out your character and you become a faceless NPC, so choose wisely.