I think a main part of that (especially liquids) is done by the so-called "MassMover". I remember there was some kind of article or documentation about it somewhere, I'll see if I can find it.

[Edit]
Can't find it anymore, the best thing is probably to ask one of the engine-devs about the massmover and PXS.

This is handled by the "MassMover". Whenever solid material is blast or shoveled away, the engine checks whether one of the new sky/tunnel pixels lies adjacent to liquid pixels. Any such liquid pixels that reach downwards or sidewards into air or tunnel materials are added to the MassMover list. Each frame, the MassMover checks for each of these border pixels, traverses upwards through the liquid body until it finds a "top" border pixel and moves that pixel directly to the bottom. If the moved pixel lies adjacent to sky or tunnel, it is again added to the MassMover to be processed next frame.

This method grows linearly in the number of border pixels. that's why flooding a small tunnel below an ocean is not a big issue. When huge oceans flood into huge caves, however, the framerate goes down.

PXS are loose, single pixels like rain or snow. They are not written into the landscape memory while they're moving (falling or sliding), but calculated and drawn from a separate list. When they reach the surface, they are converted into regular landscape pixels.

This means you cannot "swim" in rain pixels or be blocked by snow pixels, even if the precipitation is very dense.