The game's setting is a galaxy under the dominion of the Dragon Empire. The Dragon Empire is an empire ruled by the ten houses of dragons. Of these houses, five are chromatic and five are metallic. The Empire is led by Mezzenbone, an evil red dragon.

Across the galaxy, fantasy races inhabit countless worlds. Scientists and archmages in the game try to come up with a logical explanation as to why the races had similar linguistic traits. Eventually, a prominent religious leader proposed a theory: all the gods of every religion were the same, just different aspects of the twelve "True Gods". These aspects were the 12 "Deitypes," short for Deity Archetypes. Deitypes are basic, primordial, archetypal icons such as The Father, The Mother, The Magus, The Smith, The Destroyer and The Trickster. Some deities have elements of two or more Deitypes. These 12 Deitypes seeded similarities all across the life-supporting worlds of the galaxy. This theory led to a new religion that formed the basis of an emerging unified interstellar culture. The dragons eventually rose to dominate and unite this culture under a single massive Dragon Empire that rules all of inhabited space. The dragons would assimilate newly discovered inhabited planets along the edge of the Empire, also known as the Outlands.

Across the galaxy, the same fantasy races are found to inhabit countless worlds, sometimes living in great technological civilizations or magically advanced medieval cultures. When the inhabitants of many of these worlds took to the stars by magic or machine (usually both), they were amazed by their similarities. Even their languages were the same, although different dialects had evolved on the various worlds. Both scientists and archmages alike tried to come up with a logical explanation of why most worlds were almost the same, but they were stumped. Eventually, a predominant religious leader of unknown origin emerged and proposed that all the gods of every religion were the same, just different aspects of the twelve "True Gods" and their hybrid faiths.

The Dragonstar setting can easily combine preexisting Dungeons & Dragons and other D20 material and settings. A PC group can be made up of character races and classes in any combination and be rationally integrated with little work. It is similar to the classic Spelljammer setting by TSR, although Dragonstar is more of a blend of science fantasy and space opera. A basic premise of the setting is that advanced technology is sufficient to handle most tasks, but things that are considered impossible by our current understanding of physics, such as faster-than-light travel between stars, force-fields, and teleportation, are accomplished with magic. Characters use a combination of technology, conventional weaponry and magic in combat.