Cas9d, the smallest known member of the Cas9 family, employs a compact domain architecture for effective target cleavage. However, the underlying mechanism remains unclear. Here, we present the cryo-EM structures of the Cas9d-sgRNA complex in both target-free and target-bound states. Biochemical assays elucidated the PAM recognition and DNA cleavage mechanisms of Cas9d. Structural comparisons revealed that at least 17 base pairs in the guide-target heteroduplex is required for nuclease activity. Beyond its typical role as an adaptor between Cas9 enzymes and targets, the sgRNA also provides structural support and functional regulation for Cas9d. A segment of the sgRNA scaffold interacts with the REC domain to form a functional target recognition module. Upon target binding, this module undergoes a coordinated conformational rearrangement, enabling heteroduplex propagation and facilitating nuclease activity. This hybrid functional module precisely monitors heteroduplex complementarity, resulting in a lower mismatch tolerance compared to SpyCas9. Moreover, structure-guided engineering in both the sgRNA and Cas9d protein led to a more compact Cas9 system with well-maintained nuclease activity. Altogether, our findings provide insights into the target recognition and cleavage mechanisms of Cas9d and shed light on the development of high-fidelity mini-CRISPR tools.