This is wonderfully vivid. I can already see flights of stairs -- far too large for human legs -- being converted into terraced living quarters with multiple houses on each step, and a central aisle with newer stone where human-sized stairs have been added. No matter where you went within, you would feel small and uncomfortable. The ceilings are too high, the hallways too wide, and the massive doorways make you feel far too exposed. I'd love to imagine what great artifacts of legend live within the city now.
Normally, this would be a bit short to get a 5 from me, but this is spinning so many ideas that I couldn't vote it any lower. Well done!
A decent plot for a quick side-quest. A few more possibilities to add to the brew:
1. The peasant is the demon, and his target is the players. If he can get them to kill an innocent man (the priest), it will ruin their budding reputation as do-gooders.
2. There is a demon in the town, but he is not the priest in disguise -- he is posessing/controlling the poor man instead. If the players can discover this in time, perhaps they can find a way to free the priest from the demon's clutches without killing him.
3. There is no demon at all. The townfolk and the mission are pulling a scam on passing adventurers, and they will split the profits once the players are dead.
4. There is no town. The peasant is actually a brigand who is trying to lure the party into a trap further in the forest.
I can imagine the uses such a room could be put to by a later culture. They could barricade the convicted inside for a time to let them suffer, or perhaps throw newly initiated paladins or priestesses into the room as a sort of "test of purity." Hell, this could even make for a very interesting cell in a high-security prison. The person inside would be forced to remain in a near-constant state of meditation to avoid going insane.
Spawning lots of ideas, which is the important part. Well done!
Of all the magic items that I have perused on the citadel, this is one of my absolute favorites. The detail is rich, but not overwhelmed with fluff. The power is unique, and the limitations on its use creative and logical. I simply cannot say enough good about this item, so well done! I must find a way to use this one day.