Curious how iPhone knows whether I am asleep, or is it only the length of time I did not handle my phone?

I have not played with the new sleep stuff yet.. but from what I'm reading, it seems that it's mostly just a schedule that you set.

At the bottom of this link, it does mention analyzing when you pick up your phone

Set up sleep schedules in Health on iPhone - Apple Support

My guess is that it would use the Apple Watch to some extend too if you have one

this link has misc info about 2/3 down in the Health section

iOS 14 - Features - Apple

The Watch has a mode for monitoring sleep. As with most consumer sleep monitoring products it senses movement while you are asleep, on the assumption that when you are actually asleep you don’t move much. It probably also monitors your pulse. Just lying still can probably fool it, and some people move a lot in their sleep, so the results are approximate. Actual medical sleep studies use EEG monitoring your brainwaves.