For my first big trip I went to Thailand. The hotel I stayed at in Bangkok gave me the option of leaving my passport with them or leaving a deposit of about $100 US. On Ko Phangan the hotel required I leave my passport. It had been a long few days so I acquiesced. The last instance was from a scooter rental shop who wanted the passport or a exorbitant deposit. I have had it drilled into me to never hand over my passport to anyone except a government official for any reason. The only other place I have been outside of the US is Mexico where I did not encounter the passport deposit.
My questions:
Is this common anywhere besides Ko Phangan?
How has anyone else handled this situation?
Usually places are willing to take a photocopy. That said, Vietnam is one country where you do actually have to leave your passport. This is because the police have the right to ask the hostel owner for the documentation of everyone staying there. It's the law there and there's no way around it.
I often leave my passport with the people behind the front desk in hostels because it's manned at all hours, or the passports are put in a safe. If you feel the place is shady enough to lose your passport then don't stay there!