Question on the best way to insulate my block walls
Mostly people insulate a block wall like that by putting polystyrene on the exterior, then they fir out the interior with a studded wall and insulated the studded wall with batt insulation.
You may not be interested in putting poly on the exterior at this point. Hopefully the wall is waterproofed.
At any rate, it won't cost you much to build some walls on the interior with studs 2' oc, then insulate with batts and finish with drywall.
As for the ceiling, you may wish to put in more than 3.5 inches of fiberglass.
If you have the ceilings down now, I would just heat the thing and see how it works.
You didn't indicate your location, so I don't know how cold it will get. You can always throw another log on the fire.