Actually, characters and stories mentioned in Chinese mythology (in simplified Chinese中国神话) are quite contradictory to the modern understanding and some of them are therefore regarded as absurd and its authenticity has been questioned. The following is the view of some scholars about the source of the myths.
Talking about the miscellaneous myths, the scolars think that the myths were the combination and fusion of many original myths between different groups of people and after generations of transformation, the story becomes richer in content, and may also be changed beyond recognition.
About the continuation of legend, people believe that the myth of the ancient people recorded the life experience of themselves and also the perception of the subjective view of things, which reflect the social development. For example, if people were very dissatisfied with the performance of the government, the myths they left would probably be about some very strong heroes which reflect their desires. Those heroes might be too strong that their strength is beyond our imagination (like they could run as fast as a tiger). Then, this would be what we called “exaggerate” about Chinese myths.
Lastly, about the sacred myth, people believe that ancient Chinese would have these sacred myths because they had little knowledge towards the nature. If they know nothing about the nature and they do not know how to explain some of the phenomenon and therefore they would regard them as very special and myths.
In fact, myths, legends and god’s myths have slightly difference. First, myths usually refer to the mythology about nature before the Qin Dynasty. They are more focused on describing the relationship between human and nature.On the other hand, legends usually refer to some more factual stories passed orally. They are about some things about heroes that actually happened in history.
Lastly, God’s myths usually refer to some myths which help spread religious messages. In Chinese, Confuses belief is very popular and there would therefore be myths saying that having Confuses belief would help people become god and would enjoy a very peaceful life when they die.