Face ID stopped working
Yes, it is most likely that this is a hardware problem - although you couldn't really call it a "bug".

As this happened right after the phone was subjected to water, and none of the usual resets of the phone's software helped, it is most likely water damaged. You might think that an inch of water isn't much, but when you go kayaking that water isn't "pure water". It is likely that it has damaged the hardware somehow.

I would take it to Apple or a repair shop to get an estimate on the costs to fix it!