This article is considered accurate for the current version of the game.
Maps contain land and water areas. Almost all construction in a city happens on land, although bridges and crossings can span bodies of water.
Water fills channels and basins and flows downstream. The direction and speed of flow is indicated by white arrows in the water and sewage info view. The game will also simulate more dramatic water physics, such as waterfalls. as well as unstable phenomena, such as large waves. The latter are unlikely to occur in the unmodded game unless there is a dam-related catastrophe. If a building finds itself flooded, it will shortly become abandoned.
Mayors need to provide their city with water and sewage services. Most cities will extract water using shoreline water pumping stations (water towers extract groundwater, but are a more expensive option). All cities will need to discharge sewage into the map's water bodies. All water in Cities:Skylines is fresh water, however mayors should be careful not to pump sewage into the water grid. When water is polluted, it becomes purple.
Be careful with water draining and water pumping, because they will affect, sometimes greatly to the extend of sinking the city, the water level. Water tower, if more expensive and sensitive to ground pollution, will never affect the water level. The only way to not affect the water level is to reduce water consumption and thus the water drained.