First, sorry to rehash this old canard.
Second, I'm aware this topic has been addressed here: Origin of myth about the hole in the sheet?
However, that addresses R' Yose ben Chalafta's behaviour, and I've since wondered if the 'handbreadth' story of Rabbi Eliezer ben Horkanos can also be considered to have contributed more to the claims due to the 'handbreadth' terminology, such as Question 11.2.2 here: http://www.faqs.org/faqs/judaism/FAQ/05-Worship/
This seems backed up by Shulem Deen's memoir - https://images.shulcloud.com/13691/uploads/MaritalIntimacyZoomExhibit2-EliezerKaroandGer.pdf
Plus some new accounts specifically about the Ger/Gur community have come to light from Sarah Einfeld (although it mentions that it is 'probably practiced by no more than a small minority'): https://www.tabletmag.com/sections/arts-letters/articles/the-kedushah-crisis https://www.jstor.org/stable/24709805
It also seems more likely than 'gentiles saw tallit katan drying and thought they were sex sheets' (or at least seems like it would have added to it).
Can anyone confirm if the 'handbreadth' recommendation is indeed taken seriously/literally by any Hasidim, despite most authorities promoting nakedness and 'closeness of flesh' for sex? There are some groups I definitely wouldn't put it past, including cultic offshoots like Lev Tahor.