Royston has a medieval cave apparently used by the Knights Templar, a twice-weekly market and a football team that finished third in the Molten Spartan South Midlands Premier League. But one thing it does not have is much of a crime problem. A small Hertfordshire town of just 15,000 people, close to where the county meets Cambridgeshire and Essex, it is home to chemicals company Johnson Matthey and luxury confectioners Hotel Chocolat.

It is an overwhelmingly law-abiding community – there was a murder last year and a bank cash machine was ramraided, and there is the odd report of antisocial street behaviour, but there is little else to give residents a sleepless night. Yet in March a local newspaper revealed that Royston was about to become the first town in the country to have a sophisticated set of police cameras installed on every road in and out.

The seven cameras ringing Royston will record the numberplate of every vehicle that passes them, check the plate against a series of databases and send alerts to police if the vehicle is untaxed, uninsured, suspected of involvement in a crime, or appears on a local or national police "hotlist". The system – known as automatic numberplate recognition (ANPR) – has been in operation since the 1990s and, while relatively little-known, is controversial enough to have developed its own cliches. Proponents maintain that "innocent motorists have nothing to fear," while the anti-ANPR lobby routinely describes the cameras as "the biggest surveillance network that the public has never heard of".

ANPR has never been the subject of parliamentary legislation, oversight or debate. Though numberplate reads – around 14.5m are generated nationwide every day – are stored in servers that adjoin the police national computer in Hendon, north London, the cameras are operated by regional forces. Every one of the 43 English and Welsh forces now uses ANPR, with most operating a mix of mobile cameras inside patrol vehicles and fixed installations at strategically important locations.

Smaller than the yellow Gatso speed cameras every motorist recognises, the approximately 5,000 fixed roadside ANPR cameras are rarely indicated by signs, and most drivers will not realise when or where their numberplate has been recorded. Fewer still understand that each record of a car's movements will be stored for two years – five years if the plate is connected to a crime.

"I don't want to disclose too much of our tradecraft," says John Dean, national ANPR co-ordinator for the Association of Chief Police Officers, "but in the vicinity of a serious crime, ANPR can help capture the scene in the broadest sense. It cuts right across the board, from sex offenders to road safety, from fraud to terrorism. It's a brilliant tool."

Police point out how ANPR has helped to trace missing persons and identify potential witnesses to crimes; but the indiscriminate data collection has caused concern. James Welch, legal director of Liberty, says: "While there may be crime detection gains, potential for abuse is great." Royston, which sits near the boundaries of three police forces and at the junction of two A-roads, has become the unlikely frontline in this battle for British liberties.

"If they are going to put these cameras up, they should immediately delete information of vehicles that are properly registered, and only retain details of the others," says Rod Kennedy, a former mayor of Royston who believes the installation is out of proportion to the minimal crime levels in the town. "I just feel we're on this slippery slope towards where everything we do will be monitored. And I don't see why the honest citizen in a rural area such as this should have their movements tracked."

Even in a low-crime area such as Royston, ANPR can produce impressive results. Oliver Heald, the Conservative MP for Hertfordshire North East and a Royston resident, was an observer in a Herts police car when a vehicle suspected of involvement in drug crime drove past one of the town's cameras in May. A search uncovered a dealable quantity of cannabis.

"I do think it's important as a country that we don't sleepwalk into a surveillance society," says Heald, "so I can see that you wouldn't want to do this everywhere. But in a town where we've got visiting crime, and which is such an important regional hub, I think there is a case for doing it in Royston."

Inspector Andy Piper, the ANPR manager for Hertfordshire and Bedfordshire and also a Royston resident, says: "We only deal with people that we're interested in stopping – that's the criminal element that comes into our county intent on committing crime, and unsafe drivers, disqualified drivers, or people driving uninsured vehicles, who we want to take off the road."

From the passenger seat in Hertfordshire constable Andy Cundell's unmarked ANPR intercept car, it is clear that the system is as important in eliminating the vast majority of vehicles that police need take no notice of as it is in identifying the small number they want to stop.

Cundell's car has one ANPR camera, mounted on the front windscreen. Its footage appears on a screen on the dashboard; as a vehicle comes into the frame its numberplate is outlined and read. If there is a "hit" from one of the several databases the system checks against, an alert sounds and details are displayed onscreen.

The camera is surprisingly efficient, but the same is not always true of the data on which it relies. The most frequent cause of alerts is a hit from the Driver and Vehicle Licensing Authority's database of registered vehicle keepers. Roughly one vehicle in 20 during the Guardian's day with Cundell is flagged as having no registered keeper, but these are almost never followed up because the database is slow to be updated, and Cundell simply does not have time to stop what are probably innocent motorists.

On a handful of occasions, hits are registered against Hertfordshire police's hotlists of vehicles either wanted in connection with crimes, or known to be driven by people who are "of interest". Cundell stops and searches one vehicle after such a hit, but nothing incriminating is found. When a static camera half a mile from Cundell's position flags a car suspected of a string of thefts of petrol from filling stations, he gives chase along the M25 but cannot find the vehicle.

The means by which numberplates get added to police hotlists is particularly controversial. In the absence of legislation, each force can effectively choose its own policy.

"The problem is if people are being flagged for any reason that makes the police treat them as a 'wrong 'un', rather than there being a specific cause connected with a real crime," says Guy Herbert, general secretary of the campaign group No2ID. "Every time the police want to flag a vehicle on the system, there needs to be reasonable suspicion that person is involved in a crime, and there needs to be some sort of oversight on that."

Hertfordshire constabulary employs a dedicated team to manage its hotlists, with all entries reviewed at least every 12 weeks, and recent, credible intelligence is a prerequisite for inclusion and retention on the list. At least three different people need to agree that hotlisting a particular vehicle is appropriate.

"Our standard operating procedure around the use of hotlists has been taken as best practice by the National Police Improvement Agency, and we circulate it to other forces," says Piper, who considers the force's hotlists to be "99.9%" accurate. "The last thing we want is to be stopping someone when we shouldn't be. It wastes their time and it wastes ours."

In June, three campaign groups – NoCCTV, Privacy International and Big Brother Watch – made a complaint to the Information Commissioner's Office, alleging the Royston ANPR installation is illegal. Yet a potentially bigger problem may affect the entire national network. In its annual report for 2005-06, the Office of the Surveillance Commissioners expressed the view that ANPR may represent covert surveillance. The OSC declined to comment further, but the Guardian understands this remains its position. In the vast majority of cases, ANPR records that a particular vehicle was in a given place at a certain time, which would not constitute surveillance. However, long-term monitoring of the movements of any one vehicle, where no attempt is made to intercept it, almost certainly will do.

Aside from data retention periods and the lack of oversight, ANPR's semi-covert nature is the greatest point of division between the system's supporters and opponents. The cancellation of Project Champion in 2010 – a combined ANPR and CCTV installation in two suburbs of Birmingham with high Muslim populations, the counter-terror purpose of which was found to have been deliberately hidden from local people – only heightened campaigners' concerns. A key question those opposed to ANPR have is why, if they have nothing to hide, the police refuse to publish camera locations.

"All ANPR cameras, with certain exceptions, are overt in nature," says Dean. "We are happy to say, in very broad terms, where they are, but not specifically where. Disclosing the locations of cameras could be a serious threat to national security – there is a counter-terrorism requirement at key or sensitive locations."

One thing both sides seem to agree on is the need for effective legislation – campaign groups because they believe this will curb possible abuse of ANPR by police; police because it will help build public confidence in the system. Both are frustrated by the protection of freedoms bill going through parliament, which conflates ANPR with CCTV and does not promise regulation.

"What is crystal clear to me is that some people at the Home Office don't fully understand what ANPR is and how we use it," says Dean. "They seem to think that a single code of practice for CCTV and ANPR will be OK: that can't be the case, because we use ANPR in a completely different way to CCTV."

"What [the police] can't do is say, 'We should keep all information for ever just in case it might come in useful,'" says Herbert. "We want to at least preserve our privacy for the foreseeable future, rather than abolish it completely now and just trust to luck."