You take an existing game/IP and recreate it with lower fidelity, usually due to the platform of choice.
It's common to take a 3D game and then work within the limitations of removing one dimension.
Since PICO is severely limited, that's the novelty and challenge to rebuild an existing game inside it. Super fun.
For someone unfamiliar, it's also worth noting this term is used pretty loosely. (I'm guilty of this too!) E.g. Before Rivals of Aether, the same dev made a Smash clone in the GameBoy artstyle and controlset. It's understood as a 'demake' but it's a PC game and is designed for platforms way more powerful than an N64.