First things first, I'd like to say I really like this pack. It uses some very odd colors (who would think orange sand would look cute?) and its very refreshing. It reminds me alot of old NES games with its bright slightly garish colors and cute patterns.
My only wish is that whenever you update it that you would post more pictures. Like of the mobs for example: animals, enemies, etc.
Also I noticed that you want to know how to do custom water and lava! Here is how:
For starters editing the water and lava in the terrain.png file does not do anything. It literally does jack ****. Why they are even there is a grand cruel mystery of life. The only way to get custom lava and water is to use MCPatcher which you can get here: viewtopic.php?t=46173
YES, that does work with 16x16 textures. It's a common misconception that it ONLY works with 32x32 and higher. Mainly because, like many mods here, it is a cluster of confusing update notes that don't explain how anything works.
So here it is:
make a bunch of animation frames for your lava or water
tile them vertically in a new image.
16 pixels wide by however many high it needs to be to fit all your 16x16 animation frames.
name them: custom_water_still.png custom_water_flowing.png custom_lava_still.png custom_lava_flowing.png
shove them into your zip file
Run that McPatcher
select 16x16. select your texture pack. select custom/animated water and lava.
This also makes it so you can edit biome grass and leaf colors.
Your custom water and lava are now ingame and animate as well!
And remember: water supports multiple levels of transparency. just like ice.