Nightmare

Seemingly formless shadow spirits which primarily manipulate Celestial energy. Despite commonly being considered demons, nightmares rarely make use of Eldritch magic (the more common reason to seek out Celestial energy as a buffer). Instead, they use the Celestial energy as-is to form illusions when they want to (obliquely) affect the physical world. As a result, there's a case to be made that they're not really demons. They definitely exhibit the more superficial characteristics, though.

Existence

Note that nightmares are not, in fact, true formless demons. Rather, they're just more reclusive than puppeteers: while the latter extend their 'limbs' from Darkness to manipulate matter, nightmares simply peer through a crack. Until a nightmare settles to build a demesne, it has absolutely zero physical impact on the world around it, acting purely through Celestial means (illusions).
As a result, the physical existence of a nightmare is nigh-impossible to stamp out; truly killing a nightmare usually necessitates being able to cross the dimensional threshold and fight them on their home ground.

In the north

The nightmares which arise from haunts in the north are a self-perpetuating cycle of fear. Haunts turn into nightmares when thought about enough, and nightmares create attention for haunts to capture (even the term 'haunt' creates a preconception which they can play on). Unlike ordinary haunts, nightmares are mostly unimpeded by sunstone (though they can't truly infect an area with it around). Nightmares have similar, though subtler, modi operandi to fear kami. They generally act on a much greater and slower scale, building paranoia and mistrust with messages sent in half-forgotten dreams and minor compulsion illusions.
A nightmare infestation presents several challenges.

1) Identification

Without something like a ghoul's soul sense, it can be hard to recognize a nightmare infestation (as opposed to another Celestial phenomena such as an illusion, or even a mundane wave of paranoia). Drumming up paranoia about a nightmare can in itself cause a new one to manifest (a technique commonly employed by cults).

2) Removal

Nightmares are generally entirely incorporeal, meaning that they cannot be damaged by standard arcanism. However, as arcanism is inherently driven by soul movement, it's possible to use similar techniques with a very different approach in order to tangibly affect haunts. Celestial runes affect nightmares. As a result, archmages can act as an effective, if expensive and rather overkill, alternative to standard exorcists. This is why major settlements rarely have issues with nightmares. Of course, one then runs into the risk of the archmage deciding to contract the nightmare instead of outright destroying it. While archmages contracting lesser nightmares are nowhere near as powerful as the Cotd who bound the strongest one, a lesser version of the abilities apply: part of what makes a nightmare so appealing to contract is that it's a way into true sorcery for non-Cotd.

3) Aftermath

Even if a nightmare is removed, damage will still be done. Latent psychoses and such can be triggered, resulting in downward spirals for the more emotionally vulnerable. Just because the entity is removed does not mean its magics necessarily are either: existing compulsion illusions may remain long after the nightmare has been banished. In fact, the second wave of nightmares that can pop up due to laxness after eliminating the initial threat is generally more dangerous than the first instance.

Growth

In the beginning, a nightmare simply creates unease through subtle nudges. As it grows, the nightmare's soulscape begins gaining coherency. After a certain point, it gains the ability to pull sleeping minds into its soulscape, pushing them through a gauntlet of horrors. Sleep becomes difficult, paranoia rampant. The victim's division between the waking and dreaming worlds blur. Eventually, the nightmare gains enough power to locally override perceptions of reality, forcing its dream world upon the material one. At this point the entity is nigh-invincible to conventional means of damage, though anchored to its region: the only way it can expand is the spread of ideas, but the citizens are now too incoherent to feasibly travel very far.
Around this point is where new cults tend to start springing up. The nightmare sends messages to those that seem receptive to willingly giving it power. Along with power, these cultists give the nightmare direction: as is, it's essentially a Celestial virus with little will of its own, lacking a true soul. Some nightmares become influenced by the gestalts of all their cultists (or those of a certain rank etc.), while others choose an individual avatar whose will they will make manifest.
The final step, where the nightmare essentially becomes a localized reality override, is suppressed by sunstone (the material's original purpose being a dimensional anchor, after all). In a developed northern city, the furthest it gets is hallucinations, paranoia, and general insanity: while bad, it's not quite as reality-bending. This is the key reason that all northern cities are built around sunstone despite potential for other sources of light- nightmares devoured the other candidates. Every now and then, someone gets a bright idea (pun intended), and their new district ends up having to be quarantined or destroyed. Cultists become immensely powerful, as it costs the nightmare little to humor them at this point. In situations where the nightmare is hemmed in by sunstone, it tends to skip straight to the cult phase. Generally speaking, the cultists will destroy sunstone as to give the nightmare place to take root.