During the Hashira Training arc of Demon Slayer, we find out that:
Even in final arc, Upper Demon Six will be replaced (not adding details for spoiler reason). So, why are Upper Moon Demon replaced if one of the member dies? As we know, Muzan is very ruthless and wiped out the entire Lower Moon Demon due to incompetence. How does the ranking system work for upper moon demons?
Note: Please add spoilers in your answer wherever possible
Ever since Muzan was turned into a demon in the Heian era, he was always seeking a cure to protect himself from sunlight. The demon king was almost immortal, and have nearly no weaknesses or vulnerabilities. He can't even be killed after beheading.
The demon king cannot be killed even if his head was lopped off, as shown at the end of the Hashira training arc, season 4, where Gyomei Himejima chopped off his head. Muzan regenerated his head almost immediately.
Thus, the only thing that can kill him is exposure to sunlight. If he is also immune to sunlight, then he would be truly immortal. There are only two known methods that can possibly let him be immune to sunlight: devouring/absorbing another demon that managed to be immune to sunlight, or find the blue spider lily. For the first possibility, Muzan created scores and scores of demons in hopes that one day one of them will be immune. For the second possibility, Muzan created the twelve kizuki (twelve blood moons) to aid him in combat as well as in finding the lily. The twelve kizuki is divided into upper and lower ranks, each consisting of six members. Most of the lower rank moons have little screen time, with the exception of Enmu and Rui. In comparison, the upper ranks have quite a lot of screen time, appearing in almost all arcs. Apparently, Muzan trusts the Upper ranks much, much more than the lower ranks. He also needed them because of the reason stated above. When one member dies, he finds another demon he deems competent enough to be a upper moon and let them fill in the gap. These demons must be really useful and helpful to him personally, and one that garners sufficient trust and respect from Muzan. Such is the case of Nakime, where Muzan is seen profusely complementing her due to her usefulness and competence.
Thus, it is very understandable that Muzan let Nakime replace Hantengu as Upper four.
So, the MOON DEMONS are the demons that took an important amount of MUZAN's direct blood and didn't die, they were able to gain power and develop special demon techniques (like the Breath styles but demon way) through his power and they also took parts from his memory. And normal demons are just people who got bitten or were in cotact with demon blood and turned to demons.
The Upper Moons are replaced through deadly battles. The Upper Moon demons have lived a long time, eaten many people, and are very powerful, earning Muzan's trust more than the Lower Moons and receiving more of his blood. In other words, a demon who receives a lot of Muzan's blood and continues to eat people without dying will grow in power to the level of the Upper Moons. For example, Enmu from the Mugen Train arc: if he hadn't fought the protagonists directly but had continued eating people elsewhere, he might have become as strong as Daki in a hundred years.
