I'd say this was our first (or close to first) glimpse of Dukat's insanity. He was controlled and proud at the beginning of the series, but things started to change when he couldn't gain the respect of the Bajorans that he so desired, and then he really snapped after his daughter's death, and through the rest of the series we see him spiral into deeper and deeper madness. In some cases, evil comes in the form of madness (probably the scariest form of evil). And I believe that's true in the case of Dukat at this point in the character's development.
Some people say this was a mistake by the writers, and this turned a very complex, interesting character into a 2d "cartoon." I respect and understand that opinion. However, I see his daughter's death, his madness, then his involvement with the Pah Wraiths and the end of the series as part of this incredible character's sad and painful journey. It wasn't until I joined this board and started seeing the other opinions that I learned how much people really truly hated what they did with Dukat, Kira, Bajoran religion/politics, Benny Russell, Vic Fontaine and some of the other hated aspects of the show that I actually love. But that's okay. To each his own! I can't abide what they did with "Into Darkness," but others are head-over-heels for it. That's the beauty of Star Trek. There's truly something for everyone!
Pretty much how I felt too. With Dukat, I'm not sure where else they would have gone with him after "Sacrifice of Angels". I think him becoming insane added more to him than the opposite. He was already a deluded man in the beginning, so that should at least be a warning that he isn't one to look at himself objectively. He saw everything through a "I'm doing it because I care", and when he got nothing in return and lost an empire and a daughter, through his madness began to embrace the perception Bajorans had on him. "They thought I was their enemy? They don't know what it is to be my enemy, but they will."
All in all, I think it adds to his character, in a tragic way. Or maybe it's just Marc Alaimo being so good in the role that I can totally buy into Dukat losing his mind.