The reason this protects you is that if the buyer tries to back out, the escrow service still has the money. You can provide proof that you transferred the website and they can release the funds to you.
The reason this protects the buyer is that you don't get access to his money until you've transferred the website to him.
> to the buyer (who now has everything)
The buyer doesn't have everything, because they've already paid. They've just paid the escrow service, not you. Escrow.com have an arbitration arrangement, so I don't think there's too much at stake. That being said, Escrow.com is very much tailored to physical goods, so I don't know how well they'd deal with what is effectively a copyright issue.
Which makes me worried that it might be possible at this point for the buyer to refute the transaction, Escrow to then cancel the payment and I'm now stuck without a domain or at worst, I get the domain back but someone else has a) my source code and b) the ability to do anything they wish during their access to the FTP until it's removed.
I probably just don't understand Escrow and how it works.
Providing that it's a real escrow service, yes. But be careful, since "fake escrow service" is a common scam.