That's an interesting take on it and some aspects of it (the disconnect between what Jan experienced and what Bao experienced) has been something me and a few people have discussed for later stories, as you've probably read in the design book, this is firmly magical realism. The Dream is the Duel, and while the content of the dream might not be 1:1 between what Jan and Bao experienced, it's *close*.
While the idea of a Bao basically recontextualizing off screen duels as a metaphoric nightmare delusion is powerful in its own way, for me here it was using a pre-exisitng setting to highlight how Bao isn't ready for the consequences of her actions and feelings. When suffering a scarring defeat by Mickey, she doesn't blame her skill or decisions, she blames the consequences themselves. "If I didn't have to worry about this body, I would be the best.
The Dream Duels gave her a chance to test that. Sure there are physical consequences, but they're muted. Now she is confronted with the fact that she cannot handle the emotional consequences of her decision, to the point where he will breaks before Jan, absolutely humiliated by her (or, in the alt ending, actually defeated) despite holding all the power. She fails what is ultimately a test of Character. Not even through being wicked -- the school is filled with cruel, selfish people -- but through her childish nativity toward relationships and violence. She thinks she knows what she wants, but she can't even fathom the price of her desires.
I hope that's an interesting response! I really like your interpretation, even if the text didn't quite line up with where you thought it was going at the end. And beyond that, your words have been very kind, thank you for playing! 😭