Basically, Inuyasha's sword is his main weapon of protection. If it ever breaks, then his main line of defense is gone. Since Yasha is a half-demon, he doesn't have full demon blood, but because of this, he has an extra line of defense, a last resort, if you will. If he is on the verge of defeat/death, the demon part of his blood kicks in and in goes into a berserk state, losing his mind in the process. As far as the different look, well, I think anyone would look a little different if they went on mindless killing spree.
Inuyasha's father left Tetsusaiga to him to protect him, in MANY senses. he uses it to fight, but also, it seals his blood. as the son of a Greater Yokai, his demon blood is very potent, and strong (basic reason why a half demon hanyou is so strong anyways, and Sesshomaru's basic kick butt strength). if not held in check, the blood could easily overwhelm inuyasha, turning him into the berserker seen in this episode. break tetsusaiga, break the seal, the blood awakens. the blood will eat inuyasha's soul, though, if it continues to take control. soon enough, dog boy will be a mindless killing machine if he changes enough.
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