Gmail: How does Gmail's "Undo Send" feature exactly work?

Activating "Undo Send" can be a godsend if you often forget to include something in an email, or you notice a misspelling or something else you wanted to say after sending.

Enabling Undo Send will give you about 7 seconds to click "Undo" (a link on a yellow background) at the top of your email in the notification area. 

Your email is held on Google's servers until the time elapses.  Clicking Undo will cancel the send and allow you to further edit the message.

After the 7 seconds have elapsed, your message is released from Google's servers and actually sent.

It adds a 7 second delay to your send with an option to stop the send.

The description in the labs tab reads:
"Oops, hit "Send" too soon? Stop messages from being sent for a few seconds after hitting the send button."

I don't advocate email attachments -better to send links to documents instead. But If you must, and often forget to attach something to your email, another lab exists to help with that.  When hitting send, it notifies you that your email contains verbage suggesting an attachment when one does not exist.

When using Gmail in a browser:
In regards to where your message is, and where it physically goes in all of this, your message is almost always on Google's servers, even as you are typing it.  Gmail creates a draft of your message at intervals as you type. So when you hit send, it releases the message from Google's servers out to the recipient. The message doesn't really leave your computer when you hit send.  It's usually already on Google's infrastructure. 

The big benefit to this is if you turn off your computer in the middle of typing a message, and turn it back on later, your message will still be intact as a draft in your drafts folder. Great for interruptions while answering or sending emails.

It's different when using Gmail with computer software like Outlook or some mail apps on phones.  Apps and software on computers often import your messages and physically keep them on the device or computer before hitting the send button.  These software and apps require setup using pop or imap in order to use them with any email address. They also cannot use the Undo Send labs feature in Gmail.