Kill or protect Peeper. If you kill him, you'll get a lot of loot. However, if you protect Peeper, he transforms and you must fight him. You generally get less rewards (very slim chance to get source orbs however), but you will get more exp.

What happens if you don't kill peeper?

If you choose not to kill Peeper, he will transform into a Voidwoken Hatchling and summon dozens of other chicks to fight you. You will not get the quest reward and the chest will not spawn, but you can loot the dead bodies for more than one Source Orb.

What should I do with peeper?

Kill or Spare Peeper

After speaking with the Magicockerel, are two options you can take -- either kill Peeper, or refuse and spare the creature's life. If you choose to kill Peeper, you'll be given a reward of your choice.