I also believe the evil spirit/former "friend" is possessing Death. Death used to be his father, and by making his father pity him and crying in front of him, we saw how Death let down his guard in front of the evil spirit. Also, at the end of the episode, Death wasn't eating Ramen, a normal habit of his, because it was the evil spirit possessing his body.
Wol-Joo's child is Kang Bae since the Hell Queen said that her unborn child had to go through a thousand misfortunes if she didn't settle the grudges of 100,000 people. We saw scenes of Kang-Bae's sorrowful past, so we know he went through many misfortunes. However, Kang-Bae had to be born from a human in this life, so even if his soul is the same as Wol-Joo's son, he still had a human father and mother. I am not sure if he will ever find the humans by the end of this drama, but I am hoping they will address this.
Edit: Kang-Bae is Wol-Joo's son confirmed!!!!
Since Kang Bae is Wol-Joo's son, it is more likely Gwi is the Crown Prince (It is definitely one or the other). Episode 9 still hasn't revealed for sure who it is, but they gave more hints in this episode that it wasn't Kang Bae.
The girl at the end of the episode who said "Your Highness" (and Gwi and Kang Bae turned around) is suspicious though...if she is a human, how does she remember the past unless she retained in her memory for 500 years? My guess is she's a spirit and she smells trouble. I hope I am wrong though.
I hope Wol-Joo's soul will be able to reincarnate without any sacrifices from Chief Gwi or anyone else who cares about her.