It was the defending player who made the first illegal move (attempting to declare blockers of an unblockable creature). Punishing the attacking player (by erasing the legally-played ability, failing to damage the defending player, and likely losing the attacking creature to illegal blockers) makes no sense at all.
In other words, the first option (treat the creature as unblocked, deal damage to defending player) intuitively makes the most sense. However, it turns out that Magic's rules do (at least somewhat) cover this scenario. First, an excerpt from the Declare Blockers step rules:
509.1. First, the defending player declares blockers. This turn-based action doesn’t use the stack. To declare blockers, the defending player follows the steps below, in order. If at any point during the declaration of blockers, the defending player is unable to comply with any of the steps listed below, the declaration is illegal; the game returns to the moment before the declaration (see rule 726, “Handling Illegal Actions”).
509.1b The defending player checks each creature they control to see whether it’s affected by any restrictions (effects that say a creature can’t block, or that it can’t block unless some condition is met). If any restrictions are being disobeyed, the declaration of blockers is illegal.
A restriction may be created by an evasion ability (a static ability an attacking creature has that restricts what can block it). If an attacking creature gains or loses an evasion ability after a legal block has been declared, it doesn’t affect that block. Different evasion abilities are cumulative.
So, the declaration of blockers was an illegal action. There's even a section of the rules to handle those! Cool. Unfortunately, it's very short and might not exactly handle the scenario as described:
726.1. If a player takes an illegal action or starts to take an action but can’t legally complete it, the entire action is reversed and any payments already made are canceled. No abilities trigger and no effects apply as a result of an undone action. If the action was casting a spell, the spell returns to the zone it came from. Each player may also reverse any legal mana abilities that player activated while making the illegal play, unless mana from those abilities or from any triggered mana abilities they caused to trigger was spent on another mana ability that wasn’t reversed. Players may not reverse actions that moved cards to a library, moved cards from a library to any zone other than the stack, caused a library to be shuffled, or caused cards from a library to be revealed.
726.2. When reversing illegal spells and abilities, the player who had priority retains it and may take another action or pass. The player may redo the reversed action in a legal way or take any other action allowed by the rules.
As such, the official required action seems clear: the game rewinds to the Declare Blockers step, with the defending player able to assign the would-be blockers to other attacking creatures, or decline to block with them (if there are no legally blockable attacking creatures, the defending player obviously must decline to block).
Of course, some secret information may have been revealed (e.g. if somebody played an instant-speed spell in response to the illegally declared block). Provided that it doesn't violate the limitations on rewound actions in 726.1, that action just doesn't happen (unless you chose to take it again at the appropriate time). The fact that the opponent now has more information than they "should" is, essentially, the price you pay for carelessness and failing to note the illegal action in time.
In any case, since the attack was already declared, and the ability already used, legally, those actions don't reverse. As such, it's a pretty good bet that the defender will take damage. However, they will actually have an opportunity to, for example, kill the creature with an instant, or play a damage-prevention ability, even if they didn't do so "the first time" (after the illegal block), so there's no guarantee that the attack will get through until you reach that point in legal actions.
What if some illegal action happened that can't legally be reversed either? For example, suppose an effect forced you to draw a card, or shuffle your library? The general rules do not cover this scenario. Tournament rules might; I'm not a DCI judge. It's possible that the judge's decision would be "player forfeits for cheating" or "game ends in a draw because an action is both required and impossible". However, a few considerations for casual play:
- If the irreversible action was not dependent upon the illegal action, and didn't reveal any new information, one reasonable conclusion is to force the player to play it out anyhow. For example, if a spell or ability, played or triggered at the end of the Declare Blockers step, caused a player to shuffle a card from their graveyard into their library (without this specifically being caused by the illegal block), then you might decide that the spell or ability must happen again, after the rewind.
- If the irreversible action depended upon the illegal action (e.g. an effect caused you to draw a card whenever one of your creatures becomes blocked), but no new information was revealed (e.g. because you had previously placed that card face down on top of your library, legally, so you knew where and what it was), then it's reasonable to decide that the action just doesn't happen at that time (you don't get to draw; put the card back where it was) even though that constitutes reversing an action illegally.
- If the irreversible action revealed new information (e.g. drawing a card you hadn't previously placed there), there are various options. A simple one might be to undo the action in an information-minimizing way (e.g. the illegally-drawn card is placed back in the library, after which it is shuffled). However, there are situations where this is to the benefit of the player who took the irreversible illegal action (e.g. if they're mana-flooded and drew a land, they probably welcome shuffling that land back into their deck), rather than simply having it still on top to ruin their next draw). In that case, one solution that I've seen is to let the opponent decide what to do (e.g. reveal the drawn card; opponent decides whether to return it to the top of your library or shuffle it into your library or perhaps place it on the bottom of your library). This is obviously unfortunate for the person whose opponent gets to make that choice, but again, it can be viewed as the price of failing to notice an illegal play.
- In any case - but especially the third one - there's always the option to call the game as a draw or in favor of whichever player did not accidentally cheat.
