True about the setup, use the "nearest" options for upscaling, for example the 3x filter just makes each pixel appear as a 3x3 pixel rectangle, so there is absolutely no blurring, but everything naturally looks more "jaggy" and "blocky".
There is, however, another element to consider. The upscaling functions of the engine can reach up to 1280x800 (16:10) or 1280x960 (4:3 - with the option "alternate letterbox resolution"). This often does not match the native resolution of your monitor - FullHD 1920x1080 in my case, but other resolutions are possible. There are several options now how to treat the image:
1) Stretch to screen resolution - this is what most monitors and cards do by default. It will give you an image that covers the whole screen, but it will be blurred, and also distorted if the aspect ratio does not match the game's aspect ration.
2) Stretch while preserving aspect ratio - most monitor can to that. There will be blur, but the image will have correct proportions (no "fat" characters and ovals instead of circles), but there will also be black bars on the sides of the image.
3) Do not scale or "1:1" mode - the smaller image will just be displayed in the center of the screen, with black color filling the rest of the display. This is best for games like this, since there is absolutely no blur, you get a smaller, but crisp image.
Now you have also two options on how to treat the scaling - either your monitor can do it, or your graphic card can do it. Most cheap monitors do not support all three modes, plus may have poor scaling implementations. Often the best thing is to tell the driver of your video card to do the scaling on your GPU, and the GPU will just send scaled (or 1:1 image padded with black) to your monitor in native resolution, so it's often the best option.
So to answer your question - how to get rid of the blur. Use the greatest upscale multiplier in game setup that will produce resolution that still fits on the screen (4x nearest for me, resulting in 1280x800), then set your GFX card drivers to "perform scaling on GPU" and "do not scale", and voila - you will receive a perfect, but smaller image in the center of the screen.
That, or play in a window.
