Completely true to life - every prodigy in their field who becomes accustomed to winning without effort runs into this sooner or later: a rival who has encountered failure, mastered it, and channeled it into an unwavering work ethic. They lose. And suddenly their entire worldview crumbles. Some get back up off the mat, and some start running so they never have to encounter failure again. Crash and burn. The story of many lives.
The rationale "She's an olympic candidate, I could never beat her" is the classic case of a self-fulfilling prophecy. Looking at it rationally, Nagatoro's chances of winning aren't zero at all. She lost to her precisely one time, she's fit as a fiddle, and if she had stuck it out she'd have become an Olympic candidate as well, and she knows it. Her odds are 30:70 at worst. It might even still be 50:50. All she really has to do is to think back to her loss and actually analyze, with her Judo mind, what happened.
Not that winning even matters at this point. She just has to get back in the ring again. Even if she loses, she will realize that it's not nearly as bad the second time as it was the first time. She no longer has the illusion of being invincible. And when it comes down to it, just facing her fear is a win.
It's pathetic. That's completely intentional. This is a story about Senpai getting to see Nagatoro's uncool side. If there *was* a cool story behind her quitting Judo there'd be no point. She'd still be on a pedestal. If there were any doubts before, now we know Nagatoro really is just human, and she has far more in common with Senpai than she's allowed anyone to see.
That's what this arc seems to be aimed at - bringing Senpai and Nagatoro even closer together. Not making us gawk in awe at how cool Nagatoro is.