How can I make a big island (open world style) with water surrounding it?
I don't think that adding a big water prefab (standard asset) to the center of the island with big scales is a good idea, because it would be always rendered to the user which uses high amount of resources.
Should I add more, different sized water prefabs to the shore?
Which one is a better practice?
A large water object placed under land won't be frustrum culled because some part of it exists in the camera frustrum (unless you look straight up). Because of this it will be part of the back-to-front drawing pipeline and thus is not efficient. This is the danger of using over-sized polygons and/or extremely large childless objects.
If the water consisted of a individual objects; each with its prefab and mesh; then objects "off screen" could be trivially culled. Therefore you should use multiple prefabs of sufficient size so as to cullable at times via the frustrum.