My preference is for indention and no blank lines, as in most printed books.
In the mobipocket ebooks I've made, I enclose every paragraph in <P></P> tags (that's what they are for, after all). It should be a feature of the
reader to display the paragraphs as the user prefers. The default seems to be some indentation and a little bit (much less than a line) of vertical space. My Cybook currently does not allow this to be changed, but I wish it did, and I would keep the indentation and set the spacing to none.
The defaults can be overriden for specific paragraphs. The first paragraph in a chapter, for instance, has a larger space above and no indent, so it is <P WIDTH="0em" HEIGHT="2em"></P>