Here's my Hot Sonic Take: the Chao Garden works best as a complement to Sonic gameplay rather than its own thing, and a standalone Chao Garden would need to be fleshed out a lot more to be interesting.
Could it be done? Sure, but then you're designing a more full virtual pet experience, not quite the easy slam dunk of putting the Chao on mobile or whatever.
You're gonna get me to soapbox now and I apologize.
I do agree that the Chao Garden was a brilliant way to compliment the design of the adventure games, especially adventure 2. Considering the games physics engine let you fly through levels if you knew what you were doing, being invested in Chao incentivzed the player to take a more scenic route through the level. It incentivized looking for chao stuff and killing enemies they might not otherwise bother with to feed the loop. On top of that due to the games mission/a rank push it helped to keep that repetition engaging as you continued to build up your Chao.
Now if I were making an open world Sonic game, bringing back the Chao garden would be my first priority. Adding tons of chao upgrades, toys, and other gardens around the open world would be my main way of incentivizing people to explore. While it wouldn't be for everything, I think the majority would get more exited finding stuff for their Chao then finding another Korok seed. Heck considering the focus on combat, perhaps if you raise up your Chao enough maybe they could join you on the world map kinda like Feylne from Monster Hunter. Grabbing rings and other collectibles, distracting/attacking enemies, and being able to alert the player to secrets. The fact Sega didn't even consider this shows just how clueless they are.
Finally, yes a stand alone Chao game would need to be greatly expanded to work, but it obviously would. Games like Nintendogs, Seamen, Neopets, and those hamster monogatari games have shown that people will spend hours taking care of a virtual pet where the pet raising is the main focus. Heck the main toy line that clearly inspired Sonic Team for Chao and the Dreamcast vmu, Tamagotchi, are still incredibly popular with new ones released every year. Even if you wanted to do a Chao focused game that wasn't solely focused on the pet raising elements, a Chao title that focused on Chao's living their lives in an Animal Crossing or Sims style game would likely go over well with general audiences and Sonic fans as the Chao have always been fan favorites. Even ignoring their continued popularity, the Adventure games are now 20+ years old so you likely have a nostalgia market that would eat up new Chao stuff in a new Sonic game, a stand alone Chao game, or as irl merch.
The sad thing is despite all that I said, you know Sonic Team/Sega would find a way to fuck it up. They'd make the game a greedy f2p microtransaction nightmare, or the game would be really buggy and unpolished, or worse it'd be attached to a really shitty Sonic game like Frontiers and Sega would blame their inability to make a good Sonic game on the fact they spent so much time on the Chao side mode which would be the only part of the game received well by the general masses.