Just registered today and was interestered in your project. Are you still working on this ?
I know that Bernina uses a laser on their BSR regulator. That's why I am thinking about using a standard laser computer mouse to do the movement detection. The advantages would be that the movement can be detected directly on the fabric, close to the needle. One mouse would take care of both the X and Y axes. Also a mouse is cheap and more accurate than a standard potentiometer.
I am very interested in your progress.