The water dragon's lair is located in a random water-containing square of the wilderness. It contains Shyssiryxius, the water dragon (Blup's mother), her treasure hoard and various other aquatic beasts. It consists of a labyrinth and a central room containing Shyssiryxius and the treasure. The entire cave is submerged, so ordinarily some means of water breathing and the Swimming skill are required. The most common method of obtaining water breathing is through a helm of water breathing (generally a "blue helmet" before identification). Wearing two rings of the fish also grants this, although they are autocursing. If the PC is not born with the Swimming skill, it can be obtained from Blup by giving him potions of carrot juice. The need for these abilities ordinarily keeps low level PCs out of the lair, which is as it should be. The aquatic beasts found in the labyrinth are not trivial, especially the dragon turtles. Sharks and giant eels can also be found. None of these monsters see invisible.
In theory a PC with on demand teleportation, high hit points and possibly some regeneration could survive a teleport to Shyssiryxius, a chat and a teleport to the up stairs without water breathing or Swimming.
There are two main reasons for entering. The first is to 'C'hat with Shyssiryxius then return to Terinyo. This allows the PC to inform Blup about the location of his mother, which results in eventual delivery of the rune-covered trident, a decent artifact weapon and missile, later in the game. The trident is delivered not long after reaching character level 16 for PCs born in the Raven starsign. Others have to wait until level 36. The location of the lair is not decided until the PC starts searching for it, so it is more or less possible to place it in a convenient location, such as near Terinyo.
The second reason for entering the lair is to loot it. There are occasionally outstanding items found in the treasure hoard. As might be expected, Shyssiryxius does not take kindly to thieves and will attack. She does not see in Darkness, however. Cast Darkness over desired item(s), pick them up and leave.
Note that delivery of the rune-covered trident is guaranteed once the PC informs Blup of Shyssiryxius' location. The PC may then proceed to loot the cave, or indeed even kill Shyssiryxius without forfeiting the rune-covered trident.
Monsters tamed in the underwater cave can leave with the PC and breathe air. This is probably a game bug.