"You've done much to clean up the corruption around here, but we need to find the source. I'm sure CluDathoon is responsible, and we need to find out how he's doing this. I've detected a high level of radioactivity at the Tree of Corruption, as well as a small cave that appears to lead beneath the surface. I want you to check it out, and I'll meet you down there."
After leaving Nichol's house, use your compass to guide you back to the Tree of Corruption and find the secret entrance hidden beneath the root of the tree. Continue down the steps until you reach the Nether. Fly up to Nichol's house to start Chapter 3, and you can return to this location at /warp chapter3.
Note: your compass is completely useless in Chapter 3. You will not be able to use it for the rest of the chapter.