Q1 yes you are using the phrase 'watered down' correctly. Q2 ex. "The drinks at that bar are 'watered down'. " (Water down means to reduce the potency of something by adding water)

Anything can be watered down - wine, perfume, shampoo. If you can add water to dilute it, you can water it down.

Hi Ai. Thanks so much for your corrections on my notebooks. It really helps me out. I'd love to do you a favour in return but it seems all your questions get answered so quickly! Anyway, while the two answers you have here are perfectly right, I thought it might help you to know that "watered down" can also be used in a metaphorical sense. For example, a movie that has had some scenes removed (especially if it's to make it safe for children) could be called "watered down". Or a rap song with the language taken out. Like with alcoholic drinks, it means to make it less strong. Hope that helps a little. がんばって！