Complete the Mecha-Naruto World Ninja Tournament story after completing the D rank World Ninja Tournament.
For this method to work, you must have two controllers before starting. Select Free Play mode and select Single Play mode. Now, press the Start button to bring up a small options menu and set the handicap all the way to the right (The red fireball should be greater than the blue one). Have 1P choose Naruto (Sage Mode) with Ultimate Jutsu mode, while 2P chooses any character with any type of character mode. When the battle starts, press down on the d-pad to use one of the boosts, then press left on the d-pad to throw a tag at 2P. This should take him down to one health bar. Now very quickly, use Sage Naruto's Ultimate Jutsu to end the game. Keep repeating this process until you have a desired character or all of the characters. You need roughly 1780000 ryo to unlock all of the characters.
You can unlock characters by completing certain tasks or earning a certain amount of ryo in Free Play mode.