The "upgrade_diamond_hammer" item modifier's job is to automatically upgrade the Diamond Hammer for players when they have all the items necessary, and are standing in front of a Smithing Table.
Unfortunately, if a player accidentally upgrades the item by actually USING the block, they ruin the data and it becomes unusable. Whoops.
A fix for this will probably come soon, when I get the time to go back and think of something smoother.