Hare Krishna
An interesting question is when we are in illusion? And the Vedic answer is, when we take this material life as the only reality then we are in illusion. Our illusion or accepting this material world and our material body as the only reality is like accepting the dream to be reality.
1) The real reality is on the spiritual level or on the level of the soul not separate from Krishna. Therefor, to live a life on the physical plane without being aware of the soul and God is just like living in a dreamland no matter whether during the night or during the day. When the soul is awakened to its natural loving devotional activity to God, Krishna, that is its eternal, blissful, spiritual position. That is how one can quit ones Illusory dream-like existence in this material world and go back to the supreme reality, to the spiritual world, where the spirit soul naturally belongs.
2) When the soul is not awakened, it is only a bewildered observer of our night-time and day-time activities which both being not eternal are compared to dreams. Interestingly, every night we have some other dream and every other life we have some other activities in a different body. They are not eternal like the spiritual activities in the eternal spiritual body. Therefor, both of them are compared to dreams.
In the Vedic scriptures there is a description of an expansion of Krishna. That expansion is like e.g. a second candle getting the light. So, just as both candles are equally good similarly the expansion of Krishna called Maha-vishnu is equally good as Krishna, the Supreme Personality of Godhead. From the pores of Maha Vishnu billions of material universes come out. We cannot even imagine how big He is just like an ant cannot imagine how big is this universe.
So, as that Maha-Vishnu is sleeping, His dreams are said to be the activities of the conditioned living entities within the material universes. He is neither affected by the activities of all the living entities nor responsible for all their activities. Being always on transcendental position, He is always aloof from the material worldly affairs and patiently awaits when the living entities will turn toward Him.