The watch needs to be unlocked either with a PIN code or can be set to unlock on close proximity to iPhone which unlocks via Face ID (or Touch ID, or a passcode). Once it is in an authenticated state it remains unlocked while it is attached to a wrist. I’m not totally clear how it detects when it separates from a wrist (probably a light sensor, heart rate sensor or some heuristic derived from the both - but it’s pretty instantaneous and reliable). “Privileged” actions like payments or escalation prompts still require a double click of the watch’s physical button to confirm, but in this authenticated state it is possible to use the watch to unlock Mac or iPhone based on proximity alone.

It has no concept of “who” you are, only that it got positively authenticated while on a wrist by proximity to your iPhone unlock or a manual correct PIN entry and hasn’t separated from that wrist since.