LT1 V8 engines used an opto-interrupter and a very fine-pitched tonewheel inside the distributor, which was unique to that engine, driven by the cam nose, and mounted behind the water pump and directly under the water pump's shaft seal, which consistently lasted about 30k miles. I got so I could change the cap, rotor and tonewheel (>$200 in parts) in only 8 hours (you had to r&r the water pump and the electric smog pump with its incredibly stupid mount), after way too much practice. The LS1 is much too civilized for my taste, but the electrics are not under the water pump, and don't include much 'fine pitched' mechanical stuff.
I.e., I'd be wary of using an encoder on an engine, what with the delicate glass disc and small dimension optics inside and the usual instrument bearings on the shaft. YMMV.
BTW, those natural gas engines seemed to chronically misfire at low speed and low/zero load, the only way we could test the monsters, even with super high energy CD ignition. Old timers said it was the nature of the beast. YMMV.
Mike Halloran
Pembroke Pines, FL, USA