For effects like smoke or water, a fluid simulation and rendering approach is needed. There are currently two popular methods for this:

1. Simulate the fluid on the CPU and send the result as particles to the GPU for rendering as billboards. This is often called a particle system. The technique has been around since the dawn of computer graphics.

2. Simulate the fluid on the GPU and render the result into textures. This will then be rendered by doing volume ray casting (or ray marching) on the GPU. This technique is new and rather unexplored, and there are few real-life implementations. The result can be very realistic but slow.

Technique one burdens both CPU, bandwidth and GPU. Although in modern solutions, it’s the bandwidth that’s the bottleneck. The GPU based technique only burdens the GPU ( but a lot ).

The movie shows the GPU method of fluid simulation and rendering. More info about this particular implementation in the two last links.

Building an Advanced Particle System
http://www.mysticgd.com/misc/AdvancedParticleSystems.pdf
Building a Million Particle System
http://www.2ld.de/gdc2004/MegaParticlesPaper.pdf
Real-Time Simulation and Rendering of 3D Fluids
http://http.developer.nvidia.com/GPUGems3/gpugems3_ch30.html
The previous page’s authors homepage:
http://www.cs.caltech.edu/~keenan/project_fluid.html

 This method to do water is very mathematical but gives therefore a very realistic look. Specially the foam on the waves are great. The splash on the image appears if two waves hit each other.

Link to the article:
http://www.gamasutra.com/gdce/2001/jensen/jensen_01.htm

and this is the paper:

http://whitenight-games.chez-alice.fr/Docs/Water.pdf

A method in which a grid is projected in post-perspective camera space. This gives an even-spaced grid so the detail level of the water is the same over the whole screen. The image below shows the implementation of it in the 3D engine jME.

Link to the paper:
http://graphics.cs.lth.se/theses/projects/projgrid/

A method to create realistic water by combining normal mapping and vertex displacement. The water looks best when viewed from a distance.

Link to the chapter in GPU Gems that describes this method:
http://http.developer.nvidia.com/GPUGems2/gpugems2_chapter18.html