Some thoughts:

Use of AI techniques in game development

• Some AI techniques are already being used in the development pipelines of some studios. For example, image upscaling has been used to scale up textures in some remasters of older titles. But these approaches are tools that speed up the development process, not automatic solutions, and they still require being polished by an artists. See also this YouTube video on texture upscaling by Tommy Thompson.
• Similarly, image upscaling is also already being used as a post processing step in rendering pipelines. nVidia’s DLSS allows rendering a game at a lower resolution (and thus at a higher frame rate) and then using a NN to scale the frame to the target size. YouTube video on DLSS, YouTube video on the newer DLSS 3, both by Tommy Thompson.
• As far as I know, neither LLMs like ChatGPT nor text-to-image models like stable diffusion have been widely adopted so far. Personal opinion: I don’t think we will see an adoption of these techniques in the near future, for a variety of reasons. Without a lot of tinkering with their prompts, they tend to produce output that, while certainly not bad, is fairly generic and recognizable in style. They are also trained on copyrighted material and sometimes include substantial portions of a training sample in their output, which is a legal liability. Finally, you give up a fair bit of artistic control over the end result.

Your game idea

I don’t think this is viable at this point. The crucial thing to understand about LLMs like ChatGPT is that they don’t have any actual understanding of the world. The only thing they learn is to predict the most likely next word of a sentence, given the context of the conversation so far. So you could probably use them for some background character that only ever talks but never takes any actions (say, a drunk patron at a bar). But there is no way for an LLM to actually affect your simulation, so you’d need to somehow parse the conversation into a set of events in the game world, which does not seem feasible.

It’s an open source descendant of CryEngine. Basically, Amazon bought the rights to distribute a fork of CryEngine as a marketing ploy. They called this fork Lumberyard, and modified it to make it very easy to use their cloud services for online connectivity. Then they got bored of maintaining it themselves and released it as an open source project under the umbrella of the Linux Foundation.