What I understood from reading the manual is that sanity can be recovered when some puzzles are solved. As long as the player doesn't manage to do so, his sanity will get worse and worse, which makes solving the puzzles more difficult and frightening.
This sounds like a good mechanism to me... It means you can always get out of a tricky situation, but this becomes more difficult as the character gets insane. Also, when insane, the character has more trouble escaping from monsters etc. so it gets pretty dangereous. (apart from the affected vision)
(well, from what I understood
We'll see soon in the complete version. In any case, this seems a be an amazing game, very cheap. And thanks for the Linux support !! Works like a charm here will full details. (Ubuntu 10.10 beta + gf9800 GE)