It won't cut too well, yeah, but it'll definitely leave wounds, assumably puncture or penetrating wounds. Ouch.
It probably did cause a bit of fear in a few villains to a degree, but perhaps the desire to wield this said powerful object out-weighed the fear, especially seeing Sora as it's wielder. If fear is a response to threats and/or danger, then some villains did experience fear.
We're discussing how Sora's massive and dangerous magic-spewing Keyblade fails to mortify the villains of KH.
Those are in my own, personal terms, though.
It probably did cause a bit of fear in a few villains to a degree, but perhaps the desire to wield this said powerful object out-weighed the fear, especially seeing Sora as it's wielder. If fear is a response to threats and/or danger, then some villains did experience fear.