Twenty years after its potential was discussed, virtual reality has finally arrived, with headsets such as Google Cardboard offering a taste of its possibilities. Here, we trace VR's advances – and explore how it helps war veterans

My body is in the Observer's offices in King's Cross, but my mind is in another world entirely.

Strapped to my head is the Google Cardboard virtual reality headset. Assembled from a handful of simple components, the cardboard contraption has whisked me away into a peaceful forest with red, orange and brown trees.

I am completely alone, except for an grey animated rat chasing after a large orange hat. I turn my head to watch as a gust of wind blows the hat and can't help but stumble after the rodent, arms outstretched like a toddler taking its first steps.

I look away and as I gaze upwards, the Samsung S4 smartphone in the headset detects my motion and the field of view moves with me. The forest canopy is captivating. When I return to the rat, he is where I left him – the storyline effectively paused when my attention was elsewhere. Eventually, the rat and his hat are reunited and I'm suddenly back in the real world. I am intensely aware that the bridge of my nose is being assaulted by the hard edges of the headset.

Windy Day is just one of the apps for Google Cardboard, together with Google Street View and Google Earth, but is certainly its most charming. Google's do-it-yourself virtual reality (VR) headset is designed to give the public a taste of the immersive possibilities of the virtual world for around £50 – if you have access to an Android smartphone and can find some cheap glass lenses.

But it's merely the crest of a growing wave of excitement about virtual reality, most famously led by Oculus VR, the company behind the Oculus Rift headset. Purchased this year by Facebook for $2bn, the Kickstarter that catapulted the company into fame in 2012 was one of the largest crowdfunding projects ever, raising around $2.4m. This is virtual reality's moment in the limelight; it's now time for the technology to deliver.

The early 90s saw a similar amount of excitement about the possibilities of VR, with visionaries such as computer scientist Jaron Lanier predicting a future where we worked and played in virtual reality environments online.

It soon became apparent that the technology wasn't ready. Virtual reality was a nice idea, but little more than that.

This time around it's different, says Professor Albert "Skip" Rizzo, director of medical virtual reality at the University of Southern California's Institute for Creative Technologies.

"It's 1994 all over again. It's the same thing. But this time it's real," he tells me.

Rizzo leads a team looking at the use of virtual reality environments in everything from classrooms for children with attention deficit disorder to exposure therapy for war veterans suffering from post-traumatic stress disorder.

Advances in graphics, computing power and interface devices such as the Nintendo Wii or Microsoft Kinect have opened the door to a new level of sophistication of virtual reality, he says. Most important, though, has been the continuing drop in cost of virtual reality technology, a trend largely driven by the gaming industry.

"Right now, a headset is $2,000… if you could replace that with a $350 headset [such as the Oculus Rift] and have that be better then you're golden – that's the direction we're heading," says Rizzo, whose lab the Oculus Rift's inventor, Palmer Luckey, worked in before launching the headset.

The Oculus Rift, which should go on sale next year. Photograph: oculusvr.com

Accompanying the improvement in off-the-shelf commercial technology has been a boom in military interest in virtual reality. Put simply, without the wars in Afghanistan and Iraq, virtual reality wouldn't be where it is today.

"The urgency of war required novel solutions," says Rizzo, noting that tens of millions of dollars of US military funding has "fed the scientists in my lab over the last few years". The reason for that funding is simple: virtual reality offers a means of rehabilitating war veterans effectively yet cheaply.

One method being pioneered by Rizzo involves taking a veteran through a traumatic incident by immersing them in a recreation of that incident in a virtual world. Clinical trials of the method are still continuing, but "so far all the data has been promising and positive", he says.

Just as virtual reality is being used to help soldiers reintegrate into society after returning from war, it is also being used to train them for fighting in the first place.

The Defence Science and Technology Laboratory at the Ministry of Defence is investigating how virtual reality technology can be used to give the British army an edge in the field. Andrew Poulter leads the research and says that virtual reality training has a number of advantages over traditional training in the field.

Take, for example, training soldiers driving in a convoy how to respond to an ambush or an improvised explosive device (IED) attack, as troops in Afghanistan have experienced. Recreating that experience in the field repeatedly requires a significant amount of time and resources. "In a simulation, you can reset back to the beginning and go straight away again," says Poulter. Indeed, research published in 2008, looking at US, Canadian and British forces, showed that soldiers appear to be better prepared for combat when they have been trained in a virtual reality environment as well as in the field. But Poulter is somewhat downbeat about the advantage immersive headsets have over simple desktop monitors, keyboards and mouses. "There's very little done with headsets," says Poulter, for the simple reason that a headset can also prevent the soldiers from performing simple tasks such as taking notes or operating a radio.

In truth, VR headset technology still has several failings.

The display resolution of virtual reality headsets is still far behind what can be achieved with digital monitors. Nausea is another issue; users of the Oculus Rift, including the CEO, Brendan Iribe, have reported feeling sick after using the headset, an issue the company says it's working to fix in future versions of the device. One sceptic of headset technology is Professor Robert Stone from the University of Birmingham, who has worked on virtual reality projects with everyone from local heritage sites to hospitals to the Ministry of Defence.

"I've been doing this for 27 years and we always get the question – what is the killer application for virtual reality? – and, to be honest, at the moment there isn't one, because the technology is letting the side down a bit," he says.

For him, new headset technology is still held back by the same limitations that scuppered VR in the 90s and the alternative, namely large HD monitors, is a much better means for involving a person in a task or game. Furthermore, he says, VR headsets can be actively harmful to the goal of treating patients, distancing the patient from their doctor or nurse. He is also sceptical of Rizzo's work using the technology to treat PTSD sufferers

In the gaming industry, you find little of Stone's pessimism about virtual reality headsets. The Oculus Rift should go on sale in 2015, Sony is developing its own headset, the Morpheus, and several other companies are trying to get in on the game.

Developers are taking note. In 2013, UK-based company nDreams began working almost exclusively on games designed to be played with virtual reality headsets, including an adventure game called The Assembly for Oculus Rift and Sony Morpheus.

nDreams CEO, Patrick O'Luanaigh, is optimistic about the future of headset technology, describing the terrifyingly real experience of playing space horror game Alien Isolation on the Oculus Rift at June's E3 games conference in Los Angeles.

"When the alien came for me, I ripped the headset off in fear because it is so scary," he says. "That's the sort of reaction I certainly have never had before with a video game." The only comparable shift in experience, says O'Luanaigh, was the move from 2D to 3D gaming. He estimates that by Christmas 2015, virtual reality headsets will have finally hit the mainstream consumer market in a significant way. And once people start using them, they'll realise why the experience is "so special".

After only an hour with Google's Cardboard headset, a low-budget and limited virtual reality experience, it's hard to disagree with him.