It is the residence of Erazor Djinn, an evil genie who wishes to conquer the world using the seven World Rings. It floated away from the grounds of the Arabian Nights shortly before Sonic the Hedgehog arrived. The Night Palace returns to the ground after the defeat of Alf Layla wa-Layla, as the background of the final cutscene reveals. The palace has another dimension, that resembles space and the roads are made of glass. It appears once Erazor enables magic gates as a defense against Sonic. It also has gas rooms that could potentially be dangerous, so Rings must be collected to stay alive. In the middle of the first act of this stage, Sonic rides a flying carpet to reach the rest of the stage. This segment takes advantage of the tilting-system on the console, as Sonic rides the flying carpet while avoiding Djinns.
Sonic fights a large version of Erazor Djinn. After he is defeated, the player must collect the purple World Ring, the last of the World Rings. This unlocks the final boss, Alf Layla wa-Layla. Sonic transforms into Darkspine Sonic and defeats the genie.
In the cutscene where Night Palace is introduced, at the very beginning, Sonic doesn't have the flame on his chest anymore, still, the next time Sonic is within the camera, the flame suddenly came back, Same happens in-stage, at the intros of them, Sonic is still with the fire arrow, even through it was clearly established that he vanquished it before entering the palace.
The arrows launched at Sonic bears a vague resemblance to those targeted at Sonic in the Sand Oasis.
The palace floats presumably because of Erazor Djinn's magic. Similarly, Aladdin's palace in the story of Aladdin and the Magic Lamp is also moved by the lamp genie's magic.