The Mist Dragon is the first boss of Sonic and the Black Knight, found in Misty Lake's second mission, Special Challenge: Retrieve the sacred sword.
As part of his introduction to the Grand Kingdom, Sonic is being put through his paces in swordplay by Merlina the Wizard. Demonstrating a typical cocky disdain for the target practice he's been set up to this point, Sonic asks the sorceress for "something more challenging". The Mist Dragon is the hedgehog's reward for his hubris.
Flying in right at the end of the mission, the dragon squats in the center of a ruin-strewn plain, strafing its giant head back and forth. Sonic must slash at the creature's jaw with his sword, leaping out of the way when it rears back to slam the ground. Keep hacking and slashing, and eventually the creature will be damaged enough to let Sonic jump on top of its head, and lop off the blue horn in one fell swoop. Thusly defeated, the beast flies away, leaving Sonic free to reach the goal Signpost (and Caliburn).