1) Have received 3 "DenyHosts Reports" in the past day - each one containing one ip address (with the corresponding hostname, I enabled lookups). However, there are now over 800 ip addresses in my /etc/hosts.deny.

This is because you have enabled SYNC_DOWNLOAD, which downloads entries from 
other hosts' logs from the central DenyHosts server.  If you've also enabled 
SYNC_UPLOAD, you'll be helping with this too.

2) Also, logwatch reports many sshd authentication failures from various hosts, some several hundred times. Am I misunderstanding something basic? I am surprised to see so many failed attempts from the same hosts - my expectation was that once an address goes in /etc/hosts.deny, it would be blocked before it had a chance to make another (or several hundred more) bogus login attempts.

DenyHosts in daemon mode runs at intervals - there may be quite a few invalid 
login attempts between runs (defined by DAEMON_SLEEP).

--
Peter SJF Bance
http://www.minstrel.org.uk/

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