What does diff.mnemonicprefix do?

git diff shows some metadata about the files it is comparing. Ordinarily you might see something like this:

diff --git a/foo/bar.txt b/foo/bar.txt        <--
index abcd123..1234abc 100644
--- a/foo/bar.txt                             <--
+++ b/foo/bar.txt                             <--

Note how the files are differentiated using a/ and b/ on the three lines I have indicated with arrows. This is non-mnemonic; the characters a and b have no real significance.

With diff.mnemonicprefix enabled, these characters are chosen as described in the documentation you quoted. For example, if you have changes to your local copy and are comparing against the index (e.g. with git diff) you would see something like

diff --git i/foo/bar.txt w/foo/bar.txt
index abcd123..1234abc 100644
--- i/foo/bar.txt
+++ w/foo/bar.txt

instead. The characters i and w are used to indicate your index and working copy respectively.

The other cases listed in the documentation work similarly.