What does adding water during the cooking process do to a curry?
Firstly, a good rich curry can become too rich (too concentrated and even too salty) as you continue to cook it and water evaporates - that is, cooking reduces the curry.  Adding a little water can restore the balance. Yes, it “dilutes the flavour” but that may be desirable.  

Secondly, keeping the water content of your curry up to a consistent level (not too much, not too little) throughout the cooking process does ensure gentle cooking. A little gradual reduction over the cook by evaporation is fine (if that’s what you need to achieve the flavour you are after) but you don’t want to take that too far. If the curry gets too reduced during cooking you begin to alter flavours - you will even see it beginning to brown. In the end, yes, it will begin to catch on the bottom of the pan and burn.