The Simulation hypothesis wasn’t advanced by Musk (even though he seems particularly obsessed with the subject), nor it implicitly means the simulation is imitating base reality or that base reality is at all like the simulation or viceversa. Whether the simulation is a perfect copy of a reality or not, it should not be an issue for its inhabitants which would have been created from scratch inside of it. If life is a simulation, just like in the sims, its inhabitants will find themselves unable to ever reach the reality which generated theirs. Will just assume that’s how things are and even think they have been created perfect. Technology is in the early stages to allow us to create simulations that complex, but it’s definitely a possibility. And the simulation we create along with its complex systems could resemble our reality or could be programed to be something else.

Nick Bostrom is the author that has been fueling and informing a lot of Musk’s opinions on AI development and simulations and his books are definitely worth reading.