Yes, athletes in the ancient Olympics (who were all MEN, by the way) did compete in their birthday suit. It wasn't always this way, but it seems that in 720 BC, a runner named Orsipus of Megara was the first to run NAKED. One source says that he did this because he thought it gave him an edge. Another source says that he lost because his shorts fell down. Yet another says that he was killed when he tripped on his shorts. After this everyone competed NAKED, for safety's sake.
Well, there's NAKED, and then there's slightly less naked. Some young men did wear a thin leather thong, called a kynodesme, that they tied around the foreskin of their penis and to a waist belt or the base of the penis. If you search for pictures of ancient Olympians you can often see a depiction of this device on the athletes in question.
Incidentally, since all of the (men) athletes were NAKED, married women were banned from watching the games, on penalty of death. Unmarried women, though, were encouraged to attend.
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Greeks admired the body's form, specifically and especially the male body. Its strength, its fluidity of movement, the tasks it could achieve and how it worked to affect results, were studied and appreciated by some of the top philosophers in the world. It doesn't hurt an athlete's ego to have so much attention either, and none had a problem showing off their assets.
The Olympics were the pinnacle of physical humanity at the time, competing in a (supposedly) divine competition; naturally, the events were performed naked, in the truest and purest form possible, to fully showcase a person's talent.
Ancient Greek male athletes competed in the nude. The term gymnós, which is where the word gymnasium comes from, means "naked".