Actually, I think this could work out. Unfortunately, you make a really really depressing way to continue the story. I think there should be rewards as well. Any way...
Here are my few recommendations for the story:
-Change the "rules" per dream. This is not only more dynamic in story, it's also more dynamic in game play. For example, you might to medieval, modern, fantasy, realistic, etc. Especially since the character has to gain ground and try to understand it.
-You can't feel pain in dreams, right?
-I think there should be characters who are parallels of each other. Some characters
almost transfer over to other dreams but not quite different. These characters can have the "you give me deja vu like I met you before" style and this way he can actually gain companions. Even if not total companions.
-The character should have a pre-story as to why he's going through vivid, and unfortunate, dreams. Like the American show House, M.D. The asshole doctor gets shot, goes through a series of dreams where he thinks he's dreaming, wakes up, and dreams again until he learns to not be a total ass. Sort of. Either way, there comes a meaning and more symbolism with this sort of thing. Also makes more sense, can explain why certain occurring elements in his dreams occur.
-Finally,
don't give him a sword dammit! XD Just too cliche. I'm just kidding, but seriously, don't overdo the sword thing.