MkLinux runs on your hardware, and earlier kernels of the LinuxPPC distro was purported to run on nubus.
You *won't* be able to run the latest kernel on that machine unless some future (unlikely) development is done.
I use MkLinux on a 7100 and it is rock solid. Just watch what services your enable and read about any security flaws in the kernel. Update all your services you wish to run.
You can install MkLinux in as little as 300MB. Running XWindows is not at all worthwhile on these machines. Stick with a shell interface.
Not certain about the upgrade to G3, but I imagine it should run fine as-is. You may not get your L2 cache enabled without some assistance (don't know of any).
You can find the MkLinux distro at:
http://www.mklinux.org/
As for the LinuxPPC distro (it would have a more recent kernel but still a few steps back from the current) I'm not sure which one is compatible with the nubus machines. You can research it.
I think they may or may not be around any longer as a supported distro. See
http://www.linuxppc.org/