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What should i do?

Dump as many (non vital) system files as possible and use the free space to add user apps to /system/app and keep it as a gaming device and wifi browser.

Moving apps makes them survive a factory data reset.

I would also go with gbiggies idea and flash cm7.

Once you have it flashed and apps moved show it off to other ascend owners and show them what that little beast can actually do.

System files that can be deleted are anything in system/media like ringtones and alerts, wall papers, and a few others i can't think of atm but you should be able to clean roughly one third of the system Rom memory that way.
Use root explorer.
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