vhost and dns with nginx - nginx

Question

i setup a virtualbox with a clean install of ubuntu 16. installed nginx, php7, mysql all fine. the computer name is: mercury
i've setup a folder that would be the root for all my web projects: /var/www
i want to be able to have a dynamic virtual host where i can just create a folder (like: /var/www/project1) and i'll easily be able to access it via the browser at: project1.mercury
i can i achieve this? in my browser: mercury/ loads up fine (/var/www/index.html), but as soon as I use a subdomain it craps out and gives me a dns error: server DNS address could not be found
here is my: /etc/nginx/nginx.conf file
user www-data;
worker_processes 4;
pid /var/run/nginx.pid;
worker_rlimit_nofile 30000;
events { worker_connections 1024; }
http {
sendfile on;
tcp_nopush on;
tcp_nodelay on;
keepalive_timeout 65;
types_hash_max_size 2048;
server_tokens off;
include /etc/nginx/mime.types;
default_type application/octet-stream;
access_log /var/log/nginx/access.log;
error_log /var/log/nginx/error.log;
proxy_connect_timeout 60;
proxy_read_timeout 60;
proxy_send_timeout 60;
gzip on;
gzip_disable "msie6";
gzip_types text/plain text/xml text/css text/comma-separated-values;
upstream app_server {
server 127.0.0.1:8080 fail_timeout=0;
}
include /etc/nginx/conf.d/*.conf;
include /etc/nginx/sites-enabled/*;
}
/etc/nginx/sites-enabled/default:
server {
listen 80;
server_name ~^(?P<subdomain>.+)\.mercury$;
location / {
root /var/www/$subdomain;
}
}
UPDATE:
so this config works, but i need to manually update my Windows hosts file and specify the subdomain with the same ip address:
192.168.1.101 project1.mercury
if i dont, i get a dns error.
how can this be achieved without having to manually add an entry in the hosts file everytime??