Alternatively, here’s my explanation. I wrote it up while Al3x was posting his, but I might as well post it anyway… using both explanations might help you understand it better too:
Lagi was born as a mutant coolia. The heresy “program”, which is black dragon spirit that we see at the end of Panzer Dragoon Saga, is the entity that entered Lagi’s body and caused the mutant coolia to evolve into a dragon. We commonly call this dragon the Heresy Dragon, as it is refered to as that in one the books that Edge finds in the game.
How the Heresy Program entered the coolia and became the dragon is explained in the memory orbs that can be seen at the end of Panzer Dragoon Saga, while fighting Sestren. If you watch them one after another, they show the gold dragon spirit (probably Sestren), fighting the black dragon spirit (what will become part of Lagi), and forcing him to leave Sestren and enter the outside world. When this happened, the heresy program/black dragon spirit entered the coolia Lagi’s body and made him become a dragon.
So, basically, there are two parts to the dragon. The “program” and the coolia. In PDO, it is just the coolia, as the program leaves the dragon’s body at the end of PDS. They are the same, yet different parts of one whole that makes up Lagi the Heresy Dragon.
Sestren, itself, is not a physical place, but a series of astral passages beyond the physical world. Alternatively, Sestren is referred to as “the circuits of Sestren”, which implies that Sestren is a data network hosted by the Towers. So, as far as I know, Sestren isn’t physically anywhere, rather those who enter it are transformed into data and enter a virtual reality. A bit like the Matrix I suppose, except I have no idea where the bodies of those who enter it would actually be stored.
And yes, the gateway at the end of Episode 6 of Panzer Dragoon Orta leads to Sestren.
Sestren controls the Towers, which control the environment. The Towers control the pure type monsters. The dragons are the guardians of the Towers. The mutated monsters were (probably) originally pure types that have mutated over the 10,000 years since the Ancient Age. Originally, the Ancients created both the pure type monsters and the dragons. The Towers breed new pure types. One dragon is posted at each Tower, with the exception of the Tower of Uru (unless Atolm is meant to be that Tower’s guardian).
It’s also possible that Mel Kava is a replacement for a dragon guardian for that tower, but that theory is never confirmed anywhere. Also, Mel Kava is never called a Tower anywhere, although it never is not called a Tower. It’s purpose was indeed to create the fog that guarded the Tower of Uru from intruders, so if it was supposed to be a Tower, it would have to be a Tower designed to protect a greater Tower. In my opinion, if Mel Kava was meant to be a Tower it would have had a guardian dragon of it’s own.
I hope that all makes sense.