Seeing as this item will affect generally those who in some opinion may already be damned, I don't see it as too overpowering.
It seems simply to be another means for Demons to gain access to victims to possess, and is a reasonably appropriate one.
Now, as for it being eternal, etc. It sounds like it could be undone by an exorcism so long as the gem is also available to retrieve the original soul, assuming the deity of the priest performing the exorcism is willing to the help the adulterer. (Given that the spirit which has gained liberty may be a far worse one makes this likely). I think this is a more likely scenerio then bartering with the Demon.
This is also an excellent way to bring back evil NPC's that the PC's have sent to their just desserts, though possibly in a body of a different gender :)
I agree with Manfred on this one. If it can glow as bright as a torch, it either is operating as a very powerful chemical (non-magic) which would rapidly eat the wood (where else does it get the energy?), or it is magical (and would detect as magic). If magic, where did it come from and why?
The fact that it works on weapons tells me it is magical, or it would have to also convert metal into food for the fungus(and thus power the luminescence :))
So, in summary - if it is natural, then it would need to be toned down and extract energy from both wood and metal. If magic, then some info on it's origins and purpose.
While setting up camp for the night, the PC's are aproached by another group of adventurers who seem nice enough. The road is somewhat dangerous and the other group suggests camping together. The two bands split watches, one adventurer from each group watching at once. The night goes by without incident, the next day the PC's travel with the other group as they are going the same way.
The group consists of Hordel the ranger, who is skilled with the bow. Hordel is a quiet man who speaks little but appears quite skilled. Dremar is a barbarian who is a little excentric, he seems to be an excasive drinker and thiunk that battle is the solution to everything. He appears to be a stout and powerful fighter with his greataxe. Ferrin is the leader of the group, a rouge by trade. He is daft and witty, speaking with the PCs often and asking many questions. He fights with finesse with his rapier. Preminitat as a cleric but he will not say which god he worships. He uses his spells to empower and heal his party and fights with a club. He sticks close to Ferrin. Ferrin is a great talker and tells much of himself and his party, but asks even more about the history and capabilities of the PCs. He tells of some adventures his party has had, and they seem like an interesting group of mercenaries. Hordel is quite and has little interest in speaking with the PCs, he ignores most questions. He spends a lot of time with Dremar and sometimes Ferrin. Dremar seems to not care about any questions ansked to him, nor does he seem to know the answers. He seems battle hardened and is a simple man. Preminitat rarely starts conversations but will speak with the PCs. However, some of his accounts of the party's history seem to condradict those of Ferrin.
The Party spends another night and day with Ferrin's group. One of four things can happen on the third night.
1: While eating dinner around the fire, Ferrin gets into an argument with one of the PCs when he/she mentions the discepincies between Ferrin's stories and Preminitat's.
2: Hordel gets mad after repeated questioning about his life from the PCs.
3. Preminitat gets mad after repeated questioning from the PCs about what god he worships.
4: One of the PCs rejects the offer of a drink from Dremar and he takes it as an insult.
All of these scenarios result in a battle between the parties. If Ferrin's party is defeated and still lives he swears vengance. His party may then cross paths with the adventurers again.