First of all, in the days before the actual chemistry of these substances was understood, any potable liquid was likely to be considered a “water”, just as all gasses were “airs”. And of course, all alcoholic drinks, including “spirits” like whiskey, brandy and aquavit actually are largely water.
Volatile liquids, however, of which alcohol (ethanol) was by far the best known example, were, however, long associated with life, consciousness and the soul. Ancient and medieval (both Christian and Muslim) medical theory held that the cavities or ventricles within the brain were filled with a fine volatile liquid called the “animal spirit”, and that life, thought, and consciousness were all dependent on this spirit. Mental processes such as perception, thought, imagination, and memory went on not in the solid parts of the brain, but in the animal spirit that filled the ventricles. (The brain ventricles are quite real, incidentally, although what most medieval and renaissance diagrams show as a single ventricle near the front is actually a pair of two cavities, side by side. Medieval illustrators did not worry about their actual shapes either. These diagrams are intended to be read more like the block diagrams of psychological functions found in modern cognitive psychology texts than as anatomical drawings.)
The term “animal” in “animal spirit” is not so much a reference to animals in the modern sense of the word, but, rather, derives from the Latin word anima, meaning soul. Animals are called animals because they are beings with souls, but “soul”, in this sense (and as explicated by Aristotle), does not necessarily imply anything immortal, or supernatural. It merely refers to whatever it is that enables living things to maintain their organizational structure and be self-moving. A soul, in this sense, is what makes something alive, animate.
Presumably this belief in “animal spirit”, which persisted well into the Renaissance, was based on unsystematic observation that the brain and its ventricles are indeed pervaded by a clear liquid: what is now known as cerebro-spinal fluid. In reality, cerbro-spinal fluid is watery, but, presumably because it was thought to be the substance of the soul, people (most of whom never actually saw the stuff) came to think of it as being a particularly “fine” fluid, more like alcohol and other volatile liquids (diethyl ether is another example which would probably have been known to some medieval people). If you are a Christian or Muslim, and also believe that the soul consists of “animal spirits”, it makes sense that it should be a particularly volatile sort of liquid.
The volatility of spirits like alcohol, according to this way of thinking, is evidence that they are the sorts of thing that, once they are freed of earthy matter, try to rise up to heaven, their proper place in the universe. This jibes, in broad terms, with Aristotelean physics and his theory of the four elements, each of which seeks its proper place or sphere in the universe, arranged as concentric spheres: earthy, solid stuff at the centre, water above that, air in the sphere above water, and fire above that. This explains why earthy (i.e., solid) stuff falls downward, seeking to get as close as possible to its proper place at the centre, why air bubbles rise up through water, why hot, fiery air, rises, and so forth. Spirit can then be see as a fifth type of element, whose proper place is the heavens above the sky. (Aristotle did, in fact, hold that the stars, planets etc. were made from a fifth element, not found on Earth. He did not himself associate this with either souls or with volatile liquids, but the people who later did so were not departing too wildly from his general theory.)
What is more, of course, both alcohol and ether have very noticeable effects on mental functioning and conscious experience. This only reinforced the belief that these were substances of a type very similar (though perhaps not quite identical) to the”animal spirit” of the soul, that was responsible for life, thought, and consciousness.
Hence, strong, volatile alcoholic drinks, are stuff you can drink (so, a type of water) of a type closely similar to the stuff that comprises the soul, and is thus responsible for our being alive: hence “water of life”.
Really not hard to figure out.
