Daikatana takes place during the year 2455 AD, in a world suffering from a major pandemic caused by a man named Kage Mishima. It is revealed that the current dystopian world, which Mishima rules over with an iron fist, is not what the world is destined to be, and is an alternate timeline created through the use of a magical sword called the Daikatana, which allows its wielder to travel through time. The protagonist takes the form of a martial arts instructor named Hiro Miyamoto. Hiro, along with partners Superfly Johnson and Mikiko Ebihara, attempts to recover the Daikatana and return the Earth to the way its meant to be, travelling to ancient Greece (1200 BC), medieval Norway (560 AD), near future Los Angeles (2030 AD) and futuristic Kyoto (2455 AD) in the process.

Romero's initial game design, completed in March 1997, called for a huge amount of content—24 levels split into 4 distinct time periods, 25 weapons, and 64 monsters. Despite this, Romero believed that development of the game could be completed in seven months, just in time for Christmas 1997. The game was to license the existing Quake game engine. At id Software, the content portion of Quake had taken a nine-person team only six months. Romero had eight artists, and calculated that he could finish in seven. This schedule was called "patently ludicrous" by John D. Carmack. Put simply, Romero did not have an established, experienced team to rely on, as Ion Storm was still forming as a company, constantly adding new employees. Many were talented amateurs, hired on the basis of level designs they had created.

Ion Storm showed Daikatana at E3 in June 1997. The engine was still running in a software mode, and looked outdated and unimpressive. At the same time, id Software was debuting their Quake II game engine, featuring hardware acceleration and innovative visuals. Romero realized that they were falling behind technologically. The Christmas 1997 deadline was quietly dropped, and the new plan was to keep creating the content for the game, and switch to the Quake II engine as soon as it was ready. The game was rescheduled for a March 1998 release.

The Daikatana team received the source to the Quake II engine in November 1997, and immediately realized that the switch would not be simple. The code was completely different from the original Quake engine, and would require throwing away eleven months of work for a complete rewrite.

In January 1999, the switch to the Quake II engine was complete. What had been scheduled for a few weeks had taken an entire year to complete. Ion Storm announced that "Come hell or high water, the game will be done on February 15, 1999." This deadline was missed, but a demo was released in March 1999. However, this demo failed to impress players as it featured no monsters and no single-player game, only multiplayer deathmatch.

The Daikatana team was then trying to create a new, more impressive demo for E3 that year. Last minute changes to the level design led to a demo that could only run at about 12 frames per second, far less than the 30 frames per second that was considered a minimum for first person shooters. The E3 disaster led to a crisis for Ion Storm. Eidos, the parent company who had thus far financed Ion Storm to the tune of $44 million, had had enough. In June 1999, Eidos and Ion Storm reached an agreement. Eidos got majority ownership of Ion Storm, and founders Todd Porter and Jerry O'Flaherty left the company.

On April 21, 2000, Daikatana finally reached gold status. It sold 200,000 copies, which Romero claimed made up its production costs.

Nintendo 64 version

The Nintendo 64 version of Daikatana has received harsh criticism. Since it was rushed through development (it was released about 3 months after the PC version), significant concessions were made, and many of the flaws of the PC version were retained. For one, the quality of the graphics was significantly lowered. In order to keep the frame-rate up, large amounts of fog were added to certain levels, particularly in Greece. The graphics were also blurred tremendously. The characters Superfly Johnson and Mikiko Ebihara were completely removed from gameplay, yet they were retained in all of the cut scenes.

From very early on in the game's development, Daikatana was advertised as the brainchild of John Romero, a man famous for his work at id Software in the development of Wolfenstein 3D, Doom and Quake. Time magazine gave Romero and Daikatana glowing coverage, saying "Everything that game designer John Romero touches turns to gore and gold." An early advertisement for Daikatana, created by marketer Mike Wilson and reluctantly approved by Romero, was a red poster with large black lettering proclaiming "John Romero's about to make you his bitch", a reference to Romero's infamous trash talk during gaming. Nothing else was featured on this poster but a small tag-line reading "Suck It Down," an Ion Storm logo and an Eidos logo. Romero would later apologize for the advertisement, stating in an interview that "up until that ad, I felt I had a great relationship with the gamer and the game development community and that ad changed everything. That stupid ad. I regret it and I apologize for it."

Following the ad's appearance in several gaming magazines, more negative news came out of Ion Storm, fueling distaste for the game whose release was pushed back. The lavish rock star-like treatment given to Romero in his attempt to build a designer-centered game studio (including a multi-million dollar office on the top floor of a Dallas skyscraper), Romero's well-publicized expensive tastes and hobbies (such as racing Ferraris), the dubious saga of Romero's girlfriend, professional gamer Stevie "Killcreek" Case, being hired on as a level designer, and the game's development (which included most of the original development team quitting en masse to form a competing company called Gathering of Developers), incited criticism from the online gaming fan community.

Daikatana was delayed multiple times from its conception in early 1997 to its eventual release in 2000. By this time, numerous games based on more advanced graphical technology (such as id Software's Quake III and Epic MegaGames' Unreal Tournament) had already been released, causing Daikatana to lag technologically in the market with its dated Quake II game engine. Additionally, its gameplay had many aspects that were widely disliked by players, such as an artificially limited number of saves per level and the presence of computer-controlled "sidekicks" who were more of an impediment to the player. As a result, Daikatana garnered generally negative reception from reviewers and players.

The game was a major contributing factor in the closure of Ion Storm's Dallas office. In 2009, ScrewAttack named this game the #7 bust on their "Top 10 Biggest Busts", which listed the biggest failures in gaming, due to its controversial advertising and the hype that Romero built on this game, which in the end turned out to be a failure. In 2010, GameTrailers ranked this game the #2 biggest gaming disappointment of the decade, citing the game's terrible AI for friend and foe alike, pushed-back release dates, controversial magazine ad, and gossip-worthy internal drama (among other things) as "the embodiment of game's industry hubris."

• Continuous obsolescence