Challenge causes you to use moves other than just mashing square square square.
It's the same as God of War. Play on easy difficulty, you can just get through the game mashing one combo. Harder difficulty leads you to use more of the game's mechanics.
For Knack, that means the different combos with square and triangle, the shockwaves, the ground based and air based dodges/dashes, and implementing them correctly against an enemy.
The reviews do seem unfair to me based on my experience with the game, it doesn't deserve such a low score. Should be at least 10 points higher. (while still personally scoring it higher than that) But honestly, maybe I would agree with the score for this game the way it is right now if I had played through it on normal.
Despite liking the game though, there is definite room for improvements like:
Level layout, open-ness, actual story, character motivations, and the game dragged on for a few hours too long at the end. And if reviewers played on normal difficulty and were able to get through it by mashing square, then that needs to be adjusted, still offer an easy mode where this is an option, sure, but the normal difficulty mode should have you try out most of the skills available to you.
If a sequel is made, those are some things I would like addressed. More combat options, like counters, are always welcome as well.