The Eternal Conflict
The Beginning
The very first being in existence in the world of Diablo, was Anu. Anu was all, Anu was only. Following what must have been a millennia of self-reflection, Anu decided to cast out all of the evil forces within him, effectively becoming a being of pure good and light. Pretty cool right? Well, not quite...
The evil forces had to go somewhere, and those components of Anu formed another being by the name of Tathamet, the seven-headed dragon. Anu and Tathamet fought each other for eons, light against dark, day against night until they exasperated their energy into one final killing blow. The deities were destroyed simultaneously creating the Diablo lore universe equivalent of the Big Bang.
From this destruction of the two beings came the creation of other beings and other worlds. What we now know as the Worldstone, is actually the Eye of Anu, the Heart of Creation itself, and the area formed around it Pandemonium. From Anu's spine came the 'Crystal Arch' also known as the foundation of the High Heavens. From the Crystal Arch beings of light and sound are created, Angels to you and I.
Lower Pandemonium became home to a much darker force. Tathamet's severed parts formed what we now know as Hell, and the seven heads of the dragon were split to form the Three Prime Evils, and four Lesser Evils. The Black Abyss in Hell is where all demons are created.
The Eternal Conflict
When Demons aren't trying to kill and overthrow eachother, they love fighting Angels.
There is more to the Conflict than simple brawling however, the fight for control over the World Stone. The World Stone being the Eye of Anu at the centre of the Universe which has the ability to shape reality and create worlds and life.
While the Pandemonium Fortress was built to protect the World Stone, possession of the Fortress itself passed between Angels and Demons many times over during the Eternal Conflict. Whilst Angels were in possession of the World Stone they would create worlds of light and perfect order, but these worlds were also stagnant and devoid of life. Demons in possession of it made worlds of chaos and destruction, basically toddlers playrooms for evil. These worlds too were unsustainable.
Regardless the war raged on for an unspecified amount of time, but we figure a long time given the name Eternal. Worlds were endlessly created and destroyed by either side in a bid for control over the Heart of Creation.
Key Players
Demons do not live by the same rules of order as Angels, they are far more selfish and hungry for power, but they do follow a basic hierarchy most of the time when they aren't infighting. The heads of Tathamet we discussed earlier are now the Great Evils and each rule over their own domain. Generally, these seven Great Evils rule their own area and demon armies, but their are exceptions to this rule and demons that refuse to join any particular faction.
The Three Prime Evils and most powerful demons in Hell are:
Diablo - Lord of Terror
Baal - Lord of Destruction
Mephisto - Lord of Hatred
The Lesser Evils are made up of:
Azmodan - Lord of Sin
Belial - Lord of Lies
Andariel - Maiden of Anguish
Duriel - Lord of Pain
As we have covered, Angels are birthed from the Crystal Arch and are actually being born from Anu's power, which is finite therefore only a finite amount of angels can exist at any one time. If the High Heavens are at maximum angel capacity, only the death of an angel will return their energy to the Crystal Arch and be used to birth another Angel. There need to be specific conditions for this to happen, and the death of Angel does not mean they themselves will return. The process works more like reincarnation. A new angel will be born that may have some of the aspects of its former self but generally be a new being altogether.
Not all Angels are created equal, some are Archangels with greater power and status in the High Heavens. The five highest of which rule over the domain, The Angiris Council. Each archangel represents a different virtue of Anu.
Imperius - Archangel of Valor and current leader of the council.
Malthael - Archangel of Wisdom and first and oldest of the Angels.
Tyrael - Archangel of Justice
Auriel - Archangel of Hope
Itherael - Archangel of Fate
Creation of Sanctuary
Inarius was a powerful angel who served as an advisor to the Angiris Council, in fact under direct command of Tyrael. After tiring of the Eternal Conflict, he pondered the utter pointlessness of battling with demons for the World Stone and the passing back and forth of power and became disillusioned with the goals of the High Heavens. Being a well behaved angel he fought tirelessly on anyway, until one day he found himself incapacitated in battle and imprisoned by demons.
Inarius used his time in captivity to air his thoughts on the futile nature of the Eternal Conflict to his captors, and fortunately for him he found agreement in a particular demon, Lilith. Lilith was the daughter of Mephisto, also known as Daughter of Hatred and Queen of the Succubi. For a demon, Lilith was pretty hot and Inarius soon found himself utterly infatuated with her. The two fell in love and hatched a plan to rebel against both Angels and Demons and steal the World Stone for themselves thus ending the Eternal Conflict.
After recruiting some other willing volunteers to their cause from both sides of the war, they managed to steal the World Stone and harness its power to conceal themselves and it in a pocket dimension. Within that pocket dimension, Inarius, Lilith, and their followers created the world of Sanctuary. Turns out that combining the elements of order and chaos can create quite a stable world in comparison to each side's previous attempts with the World Stone.