How is something like this even possible?

I think lucid is right that it's a cellular automata, the interaction with larger objects threw me initially. Still no idea how you would get large chunks of terrain to interact like that, but they have obviously figured it out.

If anyone is interested the basic concept behind fluids in cellular automata can be found here. You can probably reproduce this using an array and a tilemap. Or perhaps just a tilemap, as it's effectively an array in itself.

jgallant.com/2d-liquid-simulator-with-cellular-automaton-in-unity