The Dal'Rok was a manifestation of the fears of the villagers, focused through a fragment of an Orb worn by the village storyteller, the Sirah. For many years, the villagers had been torn apart by hate and mistrust and the first Sirah created the Dal'Rok as a means of uniting the villagers against an external enemy and preventing the village from destroying itself. The secret of the Dal'Rok was passed down from Sirah to Sirah.
Every year, the Sirah would use a small fragment of an Orb from the Celestial Temple to create the Dal'Rok, which would then threaten the village for five nights. The purpose of creating the Dal'Rok was the unity of the village against a common foe. (DS9: "The Storyteller")
Rick Berman cited the visuals of the Dal'Rok as the reason why "The Storyteller" ended up being a very costly episode. (Captains' Logs Supplemental - The Unauthorized Guide to the New Trek Voyages, pp. 33 & 51)