Heat marshmallows and water in a saucepan over medium heat. Cook, stirring often, until the marshmallows are fully melted and smooth. Add flavouring if desired.
Slowly stir the icing sugar into the marshmallows, 1 cup at a time. Stir until the mixture becomes thick and too stiff to stir.
Scrape the mixture out onto a countertop dusted with icing sugar. The mixture will be sticky and lumpy, with lots of sugar yet to be incorporated. Dust your hands with icing sugar, and knead the fondant until all icing sugar is incorporated, and until smooth. If it is too sticky to handle, dust the fondant with more icing sugar.
Once smooth, the fondant is ready to be used. You can roll it out, shape it, colour it, or wrap it tightly in plastic for later use. If storing for later, be sure to knead the fondant again before using.
If you'd like your fondant to dry a bit harder, and/or are working with some delicate pieces, you may want to knead tylose powder into your fondant. I generally add one part tylose powder to five parts fondant. Keep in mind that your fondant will dry harder. See the tylose notes in the corresponding post as well.