Shallow frost line, little or no backfill on 3 sides,plus 12" blocks. Don't slug the blocks, you'll just be throwing money away. There are millions of block basements that have never had problems. Poured walls only became commonplace here in northern IL in the past 20 years, and they're not without problems either. Where some people get in trouble with blocks is backfilling before the house is framed up. You usually need the weight of the house sitting on the blocks to safely backfill. Doesn't look like you have much over dig so you're probably ok. Another no-no is is running a tractor or crawler on the fill to compact it.
The retaining wall is a different story. It needs the poured cap to strengthen it since there is no structure on top of the blocks.
Eddie,
Sealing blocks is no big deal. There are different products ranging from brush on to spray on. The brush on stuff is a little better for blocks because it fills the pores in the block better. Its not a very enjoyable task though. One thing no one has mentioned is that tooled mortar joints are more waterproof than non-tooled joints. Some block layers want to only strike the joints that will be visible after backfilling.
RD,
Are you going to paint the exposed block with DryLock or equivalent? Or do you have other plans like stucco or cultured stone?
Keep the updates coming! It looks like a fun project.
Pops