Lots of good ideas with lots to say!
Some additional ideas- what if when NPCs see you, they would have a chance to pull out a phone or camera and start trying to find and record you? Being recorded would drastically decrease the confidence gauge and lead to quick game overs, so you would have to be careful about being seen. You could also potentially make the NPCs quit trying to record you by putting your clothes back on and allowing them to see you fully clothed. Alternatively, have NPCs with cameras spawn and try to look for you if you get spotted enough times in one night.
I've been on the fence about cameras. I was a bit against it at first, but I'm softening up to them now since they can add a lot of options. And NPC variety is something I will need a more in-depth discussion about, as it is one of my most lacking areas in my design. Good ideas still!
What about being able to find certain items around the map that could be used to cover yourself while still technically being nude? Like finding/buying a can of whipped cream and using that to cover yourself, or putting on some bodypaint to make it harder for NPCs to realise that you're naked, etc.
I really like this a lot! I was going to save items for a future discussion, but you bring up some good ideas for them. Body paint and whipped cream seem like great ideas for items! I'd be open for more ideas of "temporary lewd outfits".
Lastly, what if you added the ability to both hide your nudity with your hands, or use your fingers to spread yourself? Covering with your hands would decrease the rate at which confidence decreases, while spreading your pussy would increase the rate at which arousal increases, but also increases the rate at which confidence decreases if you're seen. You could more easily streak through populated areas of the map by covering yourself, and spreading your pussy would give you a new way to potentially increase arousal with higher potential risk.
I had previously planned on making it manually controlled and act as "defense", much like what you wrote, but have been on the fence about it. I was thinking of having it just be an automatic, but I can see how people might want to manually control covering themselves (or not). Maybe it could be a gameplay option? It does seem like it could be a good mechanic that with a bit of depth.
As for spreading herself, I have been wanting to do some sort of pose mode where they should pose in a very revealing way that drastically increases arousal and confidence loss when seen. The current masturbation "animation" is actually already similar to the kind of pose I'm aiming for.