There is simple way to change difficulty by use of console command. I have tested it on standard version, and on 227i patch. To bring up console, press ` key, the one above Tab. The temlate of the command is this:

switchcooplevel "mapname"?Difficulty=#

You need to use it AFTER you have already started a normal coop game from game menu.

Here is the list of values corresponding to difficulty. Put this number instead of #
difficulty=0 is Easy
difficulty=1 is Medium
difficulty=2 is Hard
difficulty=3 is Unreal

Substitute "mapname" with the map you want to to play, the list of mapnames is presented below.

Example:
switchcooplevel DasaCellars?difficulty=3
However, there is a quirk: if you use switchcooplevel from the game menu, it will start singleplayer game, not multiplayer. A simple way around this is to first start a co-op game from the game menu on any map, and then once in game, use the switchcooplevel command. You only need to do this once, your chosen difficulty will preserve on subsequent map changes as you pogress through campain. Thats all, easy!

In summary:
From game menu: Multiplayer => Start new multiplayer game; Game Type: Coop Game(CoopGame); Start.
After in game: Open console, and type: switchcooplevel DasaCellars?difficulty=3

DasaCellars is a good map to verify that it works. You start in the cylindrical room, with tentacles on ceiling. On default easy difficulty, there is only one tentacle. If you successfully increased the difficulty, there will be more, 4 tentacles on unreal difficulty.

This is the list of maps in order:

Castle (Intro movie): Unreal
Vortex Rikers: Vortex2
NyLeve's Falls: NyLeve
Rrajigar Mine: Dig
Depths Of Rrajigar: Dug
Sacred Passage: Passage
Chizra - Nali Water God: Chizra
The Ceremonial Chambers: Ceremony
Dark Arena: Dark
Harobed Village: Harobed
Terraniux Underground: TerraLift
Terraniux: Terraniux
Noork's Elbow: Noork
Temple Of Vandora: Ruins
The Trench: Trench
ISV-KRAN deck 4: IsvKran4
ISV-KRAN decks 3 & 2: IsvKran32
ISVDECK1: IsvDeck1
Spire Village: SpireVillage
The Sunspire: TheSunspire
Gateway To Na Pali: SkyCaves
Na Pali Haven: SkyTown
Outpost 3J: SkyBase
Velora Pass: VeloraEnd
Bluff Eversmoking: Bluff
Dasa Mountain Pass: DasaPass
Cellars At Dasa Pass: DasaCellars
Serpent Canyon: NaliBoat
Nali Castle: NaliC
Demonlord's Lair: NaliLord
Demon Crater: DCrater
MotherShip Basement: ExtremeBeg
MotherShip Lab: ExtremeLab
MotherShip Core: ExtremeCore
Skaarj Generator: ExtremeGen
Illumination: ExtremeDGen
The Darkening: ExtremeDark
The Source Antechamber: ExtremeEnd
The Source: QueenEnd
Ending Sequence (movie): Endgame

Na Pali Map List:

Edge Of Na Pali: DuskFalls
Neve's Crossing: NeveC
The Eldora Well: Eldora
Glathriel Village: Glathriel1
Glathriel Village: Glathriel2
Approaching UMS Prometheus: Crashsite
UMS Prometheus: Crashsite1
Inside UMS Prometheus: Crashsite2
Spire Valley: SpireLand
Nagomi Passage: Nagomi
Velora Temple: Velora
Nagomi Passage: NagomiSun
Foundry Tarydium Plant: Foundry
Bounds Of Foundry: Toxic
Watcher Of The Skies: Glacena
Gala's Peak: Abyss
Escape From Na Pali: Nalic2

Go to the Unreal Gold game folder and locate Unreal.ini:
...\SteamLibrary\steamapps\common\Unreal Gold\System\Unreal.ini

The lines of interest for us are:

bInstantWeaponRespawn=true - change this to false if you dont want weapon pickups to give you infinite ammo. Each of players will still be able to pick up the weapon once.

bNoFriendlyFire=true - change this to false to enable friendly fire.

bInstantItemRespawn=false - keep this on false or else powerful items like armor and health will respawn.

Needs to be mentioned that for unknown reason, the game may ignore the changing settings for a while, and may require multiple restarts to finally incorporate the change. I had bizzare glitch when I first changed this, where some weapons would respawn, and some wouldnt. Dont give up if you dont see result right away, know that this config does work. Some patches will have these variables in game menu, so you will not need this.

I mention this In case you dont know. The console command to connect to your friend is as follows:

open "ip address"

For example: open 0.0.0.0

You will need Hamachi to connect with your friend. Unreal works well with Hamachi, no quirks there. Just copy the ip Hamachi assigned to the one of you who hosts the game, and use it in the console command. Do not listen to trollers who say something along the lines "go open ports". This is completely impossible, nobody has internet provider who gives reachable ip address, nobody. Everybody who suggests you can host just from your ip is a liar, dont listen to them.

Man you probably think I am super awesome for posting this guide. Aw, shucks ^_^. You are welcome. I am very happy to have helped, unlike those useless other guys. Other than missing UI for game variables, Unreal has exellent coop functionality. There are automatic level transitions, gear and health carryover between maps. You can play it with your friend just like you play singleplayer. Good luck in your coop game!