Decrunching is a forerunner to what we'd call unzipping nowadays. The information was "crunched" (ie compressed) to fit on one or more disks, and the "decrunched" (ie decompressed) in memory to restore to its initial state.
The flashing colors you saw were just a visual indicator of the decrunching process.
Who brought up this term anyway? Did it come from Nicolas François' PowerPacker?
(And about compacks - I might have a Defjam/CSS lying around with Stuntcar Racer and - damn forgot its name... That game with the knight battling through some bloody 2D screens. Music by Art of Noise, iirc).