I wasn't aware that they removed the ability to dig near water but this is something they had to do. It was extremely buggy and the only workaround they had in place to prevent uncontrolled flooding was a kludgy automated dam system that wrecked the landscape. Figuring out how to automatically route and flow water in response to dynamic terrain changes is not something I imagine a simple indie MMO is going to be able to tackle.
edit:
Well I see in another thread that this has in fact not been disabled but I stand by my assessment that it is extremely bug prone.
The big problem we have is digging at existing waterfalls. This will be fully blocked when we release the final version of the terrain.
The second problem with water is the dam system that Cunk mentioned. This works in most cases except it needs a few more limitations (a small dam radius and it shouldn't allow damming from a certain height in order to create tall walls.
The terraforming system will be slightly revised soon. It's on our list.