Are steps recorded when the watch is in sleep mode?

The watch does indeed record steps even after the scheduled Bed Time. What happened in your case, is most likely that you did not sync the app to the cloud before going to sleep, and just saw the total steps number on the My Day screen. And in the night, the watch probably rebooted (for example due to installing an updated component, or due to a crash), and the unsynced data was lost.

If you want to assure the final number of steps was really stored on the cloud, I recommend always checking it before midnight by taping on the Steps panel and entering the Steps screen - unlike the My Day mini panel showing the live count (same as on the watch), the dedicated Steps screen shows the value that was already synced to the cloud.

I'll have to try to do that then. Bummer I messed up a good streak.