Updating dark panel
Your objective is to make the paneling look like a wall.
Then you'll need to apply two coats of primer that is designed to cover stains and darker wood colors. There are paint primers especially designed to do this.
And if your wondering whether it pays to remove the paneling, the answer is no.
You can use 1/4 inch dry wall since you just need a thin covering.
We have not done this but saw it done on a job and on HGTV's Designed to Sell.
After applying the drywall compound, you then prime and paint as described in Option 1.