I updated my iPod touch (3g) to the iOS 4, but my hard drive filled up 1/2 way through
Since yesterday there is the iOS 4.1 update. Maybe this can be installed without problems. Or, you should be able to reset the iPod (use the link "restore iPod" under "search for updates", maybe different words, I'm using German iTunes).

BTW: You didn't try to update your iPod Touch to iPhone 4 but to iOS 4 ;)