I've noticed quite a few youtubers setting up two npcs against each other and I was wondering how.
Is it some sort of event thing in the fighter maker? or is it something you unlock?

I haven't seen any of the videos, but it's probably done by editing. Since KGT doesn't really do in-game unlockables. I've done plenty of custom matches via story settings, but I'm not sure how you'd do that as it'd probably require messing with the .demo files and such.

It's something you can do with 2D Fighter Maker. There's a Test Play option that allows you to instantly enter a fight with any character on any stage, or, have 2 CPU controlled characters fight.