Insanity Creatures

Hallucinations are neutral monsters that become hostile upon reaching 24 sanity points or lower. They will spawn once the player's sanity levels are below 75, and become gradually more visible as the players sanity level drops further. Some types will spawn during the day, and during night, others at specific times. While neutral,they cannot be attacked and will not obey physics. If hit, they will disappear in a puff of smoke, and reappear somewhere in the close proximity of the player. Up to three will spawn around the player, and begin to attack. Upon being killed, Hallucinations will sometimes drop Nightmare Fuel, used for crafting several magic items. The sanity meter will drop by both standing near and fighting Hallucinations, but will raise when killing them by 5-10 points.

Types
There are various types of Hallucinations:

Mr. Skits
Mr. Skits is a small serpent like creature that will watch from afar. Upon attempting to reach Mr. Skits, it turns and slithers away. They are harmless, but cannot be attacked.

Crawling Horror
Originally believed to be the name of all the Hallucinations, the Crawling Horror is now known to be just one type. It is a large tick-like creature, with many legs, and is the most common of the Hallucinations. Crawling horrors turn aggressive when the player's sanity is 24 and below, or if the player attacks first. Walking near these will decrease sanity. When neutral, Crawling Horrors will 'roam' similar to  Beefalo. (As of the Winter update it is no longer possible to attack this enemy until you're completely insane which by that point it'll most likely attack you first.)

Terrorbeak
The Terrorbeak is a creature with an enormous beak and slim body, with several small legs. Like the Crawling Horror, it will attack the player, but is less common. This monster will also 'roam' similar to the Beefalo, while neutral. Players can attack them most easily by trapping them on the coast or by hitting them with a Boomerang.

Shadow Watcher
Some believe it to be the shadow of the Grue, but the game files names it "Shadow Watcher." It is long and thin, with many tentacles sticking out of its head. This Hallucination is harmless and cannot be attacked. It will not disappear when stood on though, unlike Night Hands.

Night Hand
2013-02-15_00001.jpg This is a hand that extends from the shadows. While not directly attacking the player, Night Hands will attempt to do damage by putting out fires. When stepped on the Night Hand, it will shrink away into the darkness, but will still try to put out the fire. If you make the Night Hand shrink away enough (will require the player to charge towards it and continue doing so, until they are in complete darkness) the Night Hand will eventually disappear. It is not recommended to have low burning Campfires (It only extinguishes them a bit at a time). The only warning of a Night Hand is the sound of a Music Box playing. There may also be more than one Night Hand at a time, which can be very dangerous if the player are fighting a mob and will require them to keep running towards the Night Hands, and there will be more than one Music Box sound playing. The hands have been compared to Maxwell's Hands on the start screen of the game.

Eyes
When your sanity is below 75, several eyes will pop out of the darkness. Some belive them to be the eyes of the grue, although it is just speculation. They are purely for atmosphere and really do nothing, they do however disappear when you stand where they are.

Tips

 * Nightmare Fuel can be obtained more easily by killing Beardlings when the player is below 40 sanity.

Trivia

 * Hallucinations will go straight through walls while not aggresive, but if sanity is 24 or lower, they will manifest and won't pass through walls any more.
 * They become less and less transparent the more insane the player becomes.
 * The Hallucinations can appear the first day/night, provided you manage to lower your Sanity quickly enough.
 * Mr. Skitts sometimes "flashes" and turns everything else dark for a split second.
 * Their behaviour has references to the monsters in Lovecraftian literature. Being that they are so otherworldy they cause humans to go insane and their ability to move through dimensions.