Follows the instructions in this link
ODIN Guide: How to Flash and Upgrade the Samsung Galaxy Mini S5570 2.3.4 Gingerbread S5570XXKPI Stock ROM/Firmware update ~ Android Solution
coming to your questions:
You do not need to erase current firmware, as you are flashing a new firmware, old firmware is erased automatically.
It is not "room" but actually "ROM". There is no custom ROM available for galaxy mini as of now... the only firmwares that can be installed are samsung releases. Do not make experiments with these custom ROMs as some people bricked their phones already.
Now about downgrading, I think you do not need to downgrade back to froyo..because I am using gingerbread for a few days and it seems more stable than froyo and provides best performance. Before you upgrade to gingerbread you should take a backup of current firmware, but I do not know how we can do this. Yes...it is not possible to revert to froyo without doing that, but you can find froyo firmware files in samfirmware and you can install froyo back just like you do with gingerbread.