• Liquity's upgraded protocol aims to take on the increasing competition for DeFi yields, with plans to go live in the third quarter.

• The new stablecoin, BOLD, will coexist with Liquity's LUSD, adding liquid staking ETH derivatives as collateral assets to provide liquidity or leverage for investors.

Decentralized finance (DeFi) lending platform Liquity (LQTY)'s planned upgrade will include an overcollateralized stablecoin that makes use of liquid-staking tokens of ether {{ETH}} as backing assets and allows user-set interest rates for loans, a first in DeFi, according to the protocol.

"Current protocols either rely on slow and potentially misaligned human governance to adjust interest rates, or they don’t have a targeted way of using interest payments to drive demand for their stablecoin," according to a white paper published Tuesday. "Liquity V2 will change that."

Details of the new version, which is scheduled for late in the third quarter, arrive as new yield-earning strategies and DeFi-native stablecoins have helped lift investment returns from the depths of a crypto winter in 2022 and 2023. For example, Aave and Curve introduced their own stablecoins last year, while Ethena's "synthetic dollar," USDe, which generates yield by harvesting bitcoin {{BTC}} and ETH futures premiums with a "carry trade," attracted $2.3 billion in deposits.

Read more: Amid Giant Crypto Rally, Hopes for Another DeFi Summer Soar

Liquity is known as a stablecoin lender that offers 0% loans in its overcollateralized LUSD stablecoins for users depositing ETH in the protocol while charging a one-time fee. In May 2021, at the peak of the previous crypto bull market, total value locked (TVL) on the protocol surpassed $4 billion. It's now about $700 million, DefiLlama data shows.

The new stablecoin, called BOLD, will co-exist with LUSD. It will allows borrowers to take out loans by depositing ETH and liquid staking ETH derivatives as collateral while setting their preferred interest rate and plans to pay most of the revenue from borrowing fees into the stability pool and secondary markets incentivized by the protocol.

The idea behind letting borrowers set the loan rates is to align incentives: The more borrowers are willing to pay, the more revenue they contribute to the protocol to pay out for BOLD holders in stability and liquidity pools.

"LUSD is great for its decentralized capabilities, but it doesn't have the built-in flexibility to adapt to changing market environments like rising or falling interest rates," Samrat Lekhak, head of business development and communications at Liquity, said in an interview over Telegram. "In times of positive interest rates, this implies a need for a continuous yield source for the stablecoin, which BOLD provides."

Liquity plans to go live with the protocol in late third quarter of this year, Lekhak said.