We usually play 4 players, Grand Prix, 50cc, four races in a set.
Each player starts with 4 pieces of clothing. Since you probably took off your shoes and socks, that's usually shirt, belt, pants, and underwear, but if you're not wearing enough clothes, you can grab a couple markers to bring it up to 4. If you're wearing more than that, everything but shirt, pants, underwear counts as one article.
After each race, ignoring computer-controlled characters,
Obviously it goes shirt, then belt, then pants, then underwear, they don't get to pick what to take.
Since there are four races in a set, yes, you can end up buck naked if you fail hard.
If you lost a piece of clothes and won someone else's back, it's allowed that you can trade it back with someone to get your own clothes … so if Jack has your shirt and you won Sam's underwear, you can trade Sam's underwear to Jack to get your own shirt back.
You don't have to put back on the clothes you won back, but if you lost your clothes, you get them back after the next Grand Prix (four races) finishes.
After each group-of-four have played four races, the winner keeps going — the human with the highest score after four races plays against the next three players. If that guy's won your clothes, you don't get them back until he's eliminated. If there's not enough players to make a final group of four, then the 2 or 3 players in the highest rank will continue for the final round to make it even.