There's one NPC in Dreamflux Reef called Graysen who says "Even if one turns into a memetic entity with the power of the Dreamscape, those who aren't Memokeepers will inevitably wane in how the Remembrance forgets, gradually dissolve in the corrosion of the Enigmata, and quietly depart from existence just like the Watchmaker did". This essentially confirms that the Watchmaker is a memetic entity. Moreover, based on the conversation with Pisce from the event, it seems that the Watchmaker was very active until very recently, as he was drafting scripts for Clockie Studios, which means that the Watchmaker's condition probably began to rapidly deterioriate in only the last few years.
The question remains, then, if the Watchmaker is a memetic entity, how is it that he deteriorated so much faster than his fellow memetic entities? Both Micah and Nelson (another NPC in Dreamflux Reef) are from the same era as Mikhail, yet both of them are doing fine. And there is still no apparent reason to seal his child memetic self into a dream bubble.
After thinking it over, I realized there's one factor I was overlooking this entire time: the Stellaron. Mikhail has been exposed to the Stellaron probably the longest of all his generation outside of Gopher Wood, and we know that the Stellaron has the ability to tempt and influence others into tapping into its power. Just like Cocolia, and perhaps Gopher Wood, the Stellaron may have been whispering into Mikhail's ears, tempting him to use its power to turn the tables on the Family and take back Penacony. And for hundreds of years, Mikhail resisted the call, until finally, he realized that he might be reaching his limit. Thus, he enters "slumber" so that he can never act on the corruption. And it is the risk of Stellaron corruption that also forces Mikhail to lock Misha up in the dream bubble and give him amnesia. If Misha were to have Mikhail's memories, then the Stellaron's corruption would also likely extend to him, defeating the purpose of leaving Misha behind to serve as a guide to future Nameless.
Finally, there's one strange thing that Mikhail mentions in the cutscene that describes his life: he tells Clockie that he "had a long dream about the day we met". But we earlier established that Mikhail is a memetic entity, an entity existing within the Dreamscape, so how does he dream? Do his dreams exist on a deeper layer than the Primal Dreamscape? Or maybe this was a dream created by the Stellaron, and the long time Mikhail spent in the dream a warning to him that he was about to fall to its corruption.
