I guess this means i can't "restore" it at all and if i did it would render it useless with my O2 sim card?
Correct. You've just discovered the drawback to buying from unofficial sources. Many supposedly unlocked iPhones are actually hacked US ones.
It's a shame you didn't get the seller to confirm whether it was an original UK model or a hacked foreign iPhone before you parted with your money. If it had been mis-sold you may had some comeback via eBay or PayPal.
Discussions of jailbreaking are against the terms of use of this forum, so you're unlikely to be able to get much further help here.
However, if you want to be able to use the phone on O2, whatever you do, don't update to iPhone OS 3.1.3 as there is no unofficial unlock for that OS.
Other than that, I'm afraid you'll have to go elsewhere to discuss your options are far as hacking the phone is concerned.