Although English subs and dubs translate youkai as “demon,” it’s obvious that youkai have virtually nothing in common with Western demons and devils save for the fact that they are supernatural entities. The closest Western parallel to them seem to be creatures labeled as fae, but there still remain significant differences, the lack of vulnerability to iron being one.
But that doesn’t seem to answer exactly what youkai are or their actual origins.
Of course, there are demons who are born through the Parents Had Sex method, and there are demons (or at least hanyou) who are created when a human becomes a willing vessel for one or more or many youkai.
Their unique physiology suggests that their origins are, shall we say, not of this world. Besides supernatural powers and abilities far beyond what would be possible for any earthbound creature, it seems that most demons have a form of conditional immortality (don’t die of sickness or old age, but they can be killed via injury or poison or the like). And in some cases, youkai don’t even need sustenance the same way that humans and animals do. Sesshoumaru doesn’t eat human food, and we never see him eat anything in the course of the series).
But there are some intriguing clues.
It seems that youkai can manifest from emotionally potent concepts such as a mother’s grief from losing her children in war and famine (the Unmother) or from combing the hair of the dead (Yura of the Demon Hair’s true from as a red comb). It also explains why fox yokai, dog youkai, and wolf youkai don’t resemble foxes, dogs, or wolves except in the most symbolic ways.
What if youkai were originally a form of consciousness or energy that only gains material form when certain conditions are met? What if one of those conditions is a powerful emotional link between that energy or consciousness and the material world? Then that raises questions about what determines how that consciousness and/or energy initially manifests.