A novel method for simultaneously forming and filling and decorating carbon nanotubes with palladium nanoparticles is disclosed. Synthesis involves preparing a palladium chloride (PdCl2) solution in a container, having two graphite electrodes, then immersing the graphite electrode assembly, into the PdCl2 solution; connecting the graphite electrodes to a direct current power supply; bringing the electrodes into contact with each other to strike an arc; separating the electrodes to sustain the arc inside the solution; putting the container with electrode assembly in a water-cooled bath; and collecting Pd-nanoparticles encapsulated in carbon nanotubes and carbon nanotubes decorated with Pd-nanoparticles. The temperature at the site of the arc-discharge is greater than 3000° C. At these temperatures, the palladium is ionized into nanoparticles and the graphite electrodes generate layers of graphene (carbon), which roll away from the anode and encapsulate or entrap the Pd-nanoparticles. The unique nanotube structures have significant commercial potential as gas sensors or as a means for hydrogen storage.