This is the config file which developers should use locally. Ideally you should get this to be standardized. For instance you could use localhost for DB strings, and what not. You should strive for this to work on dev machines without changes.
This is the transform that is applied when you publish your application to the development staging environment. This would make changes to the web.config which are required for the target environment.
This is the transform that is applied when you publish your application to the "production" environment. Obviously you'll have to be careful with passwords depending on your application/team.
The problem with transforming the web.config that you are currently running is that a transform can perform destructive actions to the web.config. For example it may delete a attributes, delete elements, etc.