My understanding of dreams, from some basic research, seems to be that they occur during REM sleep and are likely forgotten unless waking happens during REM sleep, which is correlated with dream recall. The mechanism for this is related to the inhibition of long-term memory storage. This seems fine, but what bothered me was that during dreams I felt as if I was experiencing them in 'real-time'. Events in my dreams followed each other chronologically, I 'know' what happened in the past, and I felt like I had no awareness of future events in my dream during the dream. Of course, immediately after waking, I could still recall the events that happened, but this is after having 'experienced' all of the events.
This is puzzling to me because that seems like it would mean that my 'experience' of dreaming would somehow predict my waking: since if I wasn't about to wake up, I would have no recollection of my dream.
I came to two possible explanations for this (that at least seemed plausible to me, although being not highly versed in the field of neuroscience, the actual explanation could completely different):
The 'experience' of the dream happens in the moments of waking. When I am dreaming, I am not experiencing them as they form, but rather they are 'replayed' after already having been formed in the seconds of waking, but not yet being fully awake.
I am 'experiencing' the dream as it happens, but my brain forgets it unless I wake up shortly after. This means that I've also 'experienced' the dreams that I did not remember, they simply were not stored in long-term memory due to still being asleep. Wakefulness prevents the mechanism that causes me to forget the dream.
If 1 is true, then that would mean that some form of 'time-dilation' is happening in my mind. I 'feel' as if dreams last for at least some minutes, but that experience would have to fit in the span of seconds for 1 to be true.
If 2 is true, then to me it still doesn't resolve the issue of 'predicting' wakefulness. Were I to be 'experiencing' a dream, then that would still mean that I'd be waking up shortly after else I'd not have 'experienced' it, like all the dreams before it that I did not remember experiencing. This also sounds like a pandora's box of philosophical questions that could be asked about consciousness and memories.
My question is: Is the explanation of the 'experience' of dreams closer to hypothesis 1 or 2, or is it something completely different?