Notices

I have just tried the dnsmasq way to add a custom hosts file without change /etc/hosts and it works fine. Probably this would be the best option to avoid configuration dialogs or changes to users previous customizations.

Well, /etc/hosts always worked just fine for me, so I always sticked with it.

Yes it is a huge list but it doesn't matter so much like the ip blacklist which is working with iptables rules instead to have a file for dnsmasq.

With too many iptable rules the speed and memory decrease.
A huge file for look up will also decrease the speed but noot so much.

And there is no big difference to save hosts in /etc/hosts or in a dnsmasq related file only that services who also look in /etc/hosts are faster and you can have a personal /etc/hosts file and the blocking in a different file. In my eyes it is more structured, clean and save that nothing get over written in /etc/hosts.