Most knock sensors in use today are microphones. The most common sensor type is a piezoelectric crystal type.
Failure is detected by: 1 Testing the circuit during a power on self test. 2) watching for signal thresholds during normal engine knock producing operating conditions. Field testing is done with an oscilloscope and a hammer. A tap on the engine block should produce a voltage signal on a scope. Plus and minus 2 volts is common. Voltage varies with signal strength.
P0325 is the standard failure code.
Engine damaging knock is quite loud and would be obvious to a driver. Almost always heard on acceleration.
As usual OEM failure engine management strategies vary but the most common is to limit timing advance to a known safe range. This will limit both fuel mileage efficiency and power.
Failure is common among some makes and less so with others. For example Subaru installed a high failure sensor from the mid 90's to about 2003. But Toyota sensor failure is uncommon.