Just discovered this thread, GG! My heart goes out to you, your DW (dear wife) and your little GD! Bless you and DW for taking GD in and giving her a stable, loving home. I haven't had this experience, myself, but have seen many GPs online who have, as well as some IRL (in real life), and I admire you all.
I'm glad DD was willing to let that happen, also. I'm sorry about the life she has chosen, and I know it must hurt you and DW, but I'm glad she let you have GD. Also, I'm sorry she lies and says she has "lost custody" of GD. But I imagine that's b/c she's embarrassed to admit she gave her up so easily. The fact that she still sees her, takes her out, and "spoils her" suggests to me that she does love her in her way, but would rather play the role of a sort of much older sister or favorite aunt than an actual mum. Besides, a child just doesn't fit into her chosen lifestyle, and I'm glad she realizes that.
Regardless, I don't think you should ever let her come and live with you (and I doubt she would want to b/c of the different ways of life). There's too much risk of her disrupting the stability you've given GD. Plus, if Social Services decides GD should not be living w/ her, they might take GD out of your home. IMO, your priority has to be GD now. Unfortunately, this is the situation DD and the dad have created.
Speaking of the dad, I agree that you did the right thing. GD should not be subjected to so much confusion and disappointment. As for his abusive comments and accusations, I would ignore them. Iv heard/read that this is common in these situations. He's really trying, it seems, to avoid facing his guilt and irresponsibility. He also may be trying to bully you and DW into dancing to his tune. Kudos to you two for not giving in to that!
Mostly, I'm glad the SGO is progressing and wish you, DW, and GD the best! I hope life works out for DD, too, even though it probably won't be in the way you or I would want.