Klonoa: Door to Phantomile is a side-scrolling platform game viewed from a "2.5D" perspective. The player moves the protagonist, Klonoa, along a path in a two-dimensional fashion, but the game is rendered in three dimensions. This allows the path followed to curve and for the player to interact with objects outside of the path.

The game is set in Phantomile, a land fueled by dreams people have at night. An anthropomorphic animal named Klonoa has had a dream about an airship crashing into a nearby mountain known as Bell Hill, and the next day an airship does indeed crash into the mountain. Klonoa and his friend, a "ring spirit" named Huepow, decide to investigate. They find a dark spirit named Ghadius and his henchman Joka on the mountain searching for a magical moon pendant so he can turn Phantomile into a world of nightmares, all the while kidnapping the diva Lephise in order to prevent her from renewing the world with her "Song of Rebirth". After a brief scuffle, Klonoa finds the pendant under a bell and ventures back to his home in Breezegale, where his caretaker, Grandpa, tells him that the chieftess of the nearby Forlock Forest, named Granny, knows about the pendant. The pendant is left with his caretaker.

Klonoa and Huepow travel there to find Granny, but end up having to detour to the kingdom of Jugpot to stop the water from flowing backwards, which was something done by Ghadius in order to kill off Forlock Forest. After rescuing Granny from Joka, she tells them about a legend that involves the pendant, the legendary moon kingdom, Ghadius and "the dream not of this world". Granny asks about where the moon pendant's being kept, and Klonoa answers by saying that Grandpa has it. Joka eavesdrops on the conversation, and ventures off to steal the pendant before Klonoa can arrive back. Once there, Joka ends up bombing Klonoa's home while Grandpa is nearby, stealing the pendant after doing so. Klonoa is unable to reach Grandpa in time and he ends up dying in Klonoa's arms, but not before telling him to get the pendant back, which he says is his destiny. Klonoa is distraught by the loss of his caretaker, but Huepow reminds him of their mission.

With the help of the flying fish Pamela, Klonoa and Huepow head to the Temple of the Sun and confront Ghadius at the top, asking him about his motivation in turning Phantomile into a world of nightmares. Ghadius answers by saying he is motivated out of revenge against those who banished him. Ghadius disappears, and Klonoa ends up battling Joka. After Joka's defeat, the moon kingdom, Cress, appears. Klonoa and Huepow make their way there with Pamela's help. There, Huepow reveals himself to be the prince of the moon kingdom, saying that his "ring spirit" form was merely a disguise. Klonoa continues to help Huepow and they make their way to Ghadius, whom they eventually defeat. However, an ancient nightmarish beast known as Nahatomb, who was birthed using the diva Lephise as a living battery and Ghadius' own nightmares, is revived just before he dies. Klonoa and Huepow eventually defeat Nahatomb and restore peace to Phantomile, with Lephise thankful of her rescue.