You don't sign the whole image as a stream, and you don't sign every block. Recursion is your friend! You sign the Merkle tree root, check it once, and then check O(log n) hashes per block access. You can, of course, amortize the checking of the first several of those hashes as a further optimization that ties in easily with your caching layer.

There's no such thing as "the block doesn't decrypt" absent MACs/MICs or AEAD schemes -- encryption and decryption are just maps from N bytes to N bytes.