Yasyuki Udea, the show's producer, makes it clear in this Otakon Panel Interview:

"Ueda:

Mika became a victim of the wired. Lain started delving into the wired, so did Mika, and Mika got stuck in this nether world in between, so while she still exists in the physical world, anything she says and does is kind of like a fax, it just comes out, but it's not actually her because her self is still kind of stuck in the wired, so her existence is kind of like a puppet state."

Mika's consciousness was ejected from her body via the Knights hacking her brain through her computer. We see a memory of this happen flashing through Lain's mind in Layer 10. They then eject her consciousness from her brain to fulfill their prophecy. We see this prophecy earlier in Layer 5, it being:

"Hell is full, the dead have nowhere to go"

We see the Knight's logo fall over Mika in Layer 5 and then see Mika disappear  as a ghost into the Wired. The Wired was at the moment growing with protocol 7 gradually replacing protocol 6, thus connecting the spirit world to the Wired. However, it wasn't able to keep up with the amount of people giving up their bodies to live on forever in the Wired.

The Knights then run her body with a program that is then used to conduct surveillance on Lain and plant the parasite bomb on her computer that explodes in Layer 6: KIDS. When said program is no longer in active use, it reverts to its braindead state of being a signal receiver. Originally, back in the 2000's it was telecom companies who dealt with internet connections, so most people had to "dial up" the internet. What we  see here is the Knights remotely hacking into Mika's brain via the Wired.

In Japanese, "pikaa tto" is the onomatopoeia (scroll down ) for "lightning". And since audio on a computer is basically an electric signal, Mika is basically vocalizing the dead signal of a phone beep.We see her reactivate when Lain plays track 44, which signals the Eiri/Knights.

We know that brains can be remotely hacked via terminal devices used to access the wired from the kid with his handheld console in Layer 3, and from Tachibana and the Men in Black frying every Knight's brains via their devices in Layer 10. We also see a memory of Mika accessing her computer in Layer 11 as a memory Lain accesses when she enters Mika's room. Mika's room has a computer lying on the floor.

Why did the Knights do this? The surveillance method is one reason, but we have to understand that as a cult, the knight's version of the Truth relies on the fact that they believe the Wired is the real world and the physical body is unnecessary, which is why they create situations where people lose their physical bodies, such as the phantoma, the girl on the tracks, the accela dude etc. This has more to do with the Knight's personal belief system.

On top of that, they're just fucked up people lol.

Who was Mika? I don't have a clue exactly, but there are some clues:

1. We see that when Lain reconstructs the timeline from scratch and reverts everyone back to their original physical form, even Eiri, the man who tortured Lain is shown mercy and given his original body and his memories. However, the camera doesn't cut to Mika's face and we only hear her voice.

2. Mika clearly remembers Lain as her real sister despite the memory rewrite Lain recovers in Layer 9. Therefore, Mika's own memories were overwritten. If Mika was really Yasuo's daughter, I doubt he would let that happen.

3. Yasuo and his wife clearly leave Mika for dead in the house and leave. They clearly don't value Mika. I can understand Lain, but not Mika.

4. Serial experiments Lain does have a recurring theme of adults exploiting children for their own ends, examples being Taro, the Knights with phantoma, Hodgeson and the KIDS experiment and most prominently Eiri and Tachibana with Lain.

I have a slight hunch that Lain's body is a clone of Yasuo's (Lain's fake dad's) dead daughter, considering that building a human from the ground up is likely much more difficult than simply cloning one. 

The reason for this is how Lain's room looks very different in the memory rewrite in Layer 9 vs Layer 1, which to me could mean that Yasuo was trying to keep his daughter's memory alive, a phenomenon commonly observed in parents whose children pass away at a young age.

This in turn could be the reason why Lain smiles in her house in episode 1 (there's no way she could have a memory of a past she never had, unless she's experiencing a memory in her artificial consciousness), why Lain's mom is so cold to her and Yasuo is warm,  and why Lain's dad and mom eventually leave the house without Lain and Mika, both of them very likely being synthetic clones of his daughters.

You may also be interested in this article (which has a lot in common with the stuff in SEL) concerning Morphic fields. Rupert sheldrake goes into detail about the concept here. Morphic fields are briefly touched upon in Douglas RushKoff's book Cyberia, which is briefly touched upon in SEL. The concept basically explains how memories can transfer through genetic matter.

Since they were always dead anyways, it's time for Yasuo and Miho to stop living in a fabricated fantasy and instead return to reality.I mean Yasuo literally says he enjoyed "playing house" in Layer 10. And House is a game where kids pretend to be nuclear families with dolls as their own children.

I MAY be overthinking it, but we see what is supposedly Mika eat western food in Layer 13, but both Yasuo and his wife do not call her Mika at all, and the camera never shows us her face, but we do know that only Lain eats western food in layer 1 and layer 5, considering she's the only one who eats with a shallow bowl and spoon, while the rest of her family uses the deeper bowl and chopsticks, including Mika. There are only 3 chopstick sets here.

The fact that Yasuo and Miho let their house plants die was maybe because they decided to move on from these memories. In fact, Yasuo may have started working at Tachibana and headed the genome mapping project for the sole intention of resurrecting his daughter.

In the end it is this daughter is who Lain resurrected at the end via Psi, which is neither Lain nor Mika, which is why the show hides the face and name of this person from us despite it having the voice of Mika.

How did this daughter die? A theory I propose is this. We see Yasuo look at Lain's chair at the dinner table struggling to remember her, despite Lain deleting him from her memories. In a similar way, Mika has a fixation with the car rushing past her in layer 5, cinematography wise. It seems to imply an accident of some sort, which is later revealed to be a consequence of the knights hacking the traffic control center.

We also see the screen briefly flash in Layer 11 between Mika and the Tachibana labs genome sequence scene, which is the only point during the recap where two scenes rapidly overlap between each other. This is could be construed as a hint in this direction. We also see in Layer 4 at the very end that as the camera pans to Mika's perspective when Lain exclaims "welcome home sis!", the sceeen shows a security cam feed with its associated static. This means that Mika has always been an android/synthetic human at some level, whose job has from the very beginning been to spy on Lain.

TLDR: Mika was brainhacked by the Knights remotely one day when she was using her computer as part of both a cult ritual, as well as to survey Lain. She (like Lain) is most likely a human clone of Yasuo Iwakura's dead daughter who died in a car accident. In Layer 5 her soul is ejected into the Wired where it completely dissolves. At the end of the show, Lain resurrects the original "Mika" who died in the car accident.