One needs to understand the song and its history.

From Wiki:
Dylan, recovering from a motorcycle accident which had marked a shift in his career, had been seen reading the Bible on a daily basis.[5] As with many of the lyrics to the songs on this album, the words to "Watchtower" contain biblical and apocalyptic references.

The Book of Isaiah, Chapter 21, verses 5-9, contains the following: "Prepare the table, watch in the watchtower, eat, drink: arise ye princes, and prepare the shield./For thus hath the Lord said unto me, Go set a watchman, let him declare what he seeth./And he saw a chariot with a couple of horsemen, a chariot of asses, and a chariot of camels; and he hearkened diligently with such heed./...And, behold, here cometh a chariot of men, with a couple of horsemen. And he answered and said, Babylon is fallen, is fallen, and all the graven images of her gods he hath broken unto the ground."

The song depicts a conversation between two people, a "joker" and a "thief", about the difficulties of getting by in life ("There's too much confusion"). The joker is concerned about losing his property, while the thief observes that some individuals among them aren't taking life as seriously as they should: "There are many here among us who feel that life is but a joke." The joker suggests that time is running out. In the last verse, the viewpoint of the song switches abruptly. The ruling princes stand guard in a watchtower over their women and servants as an unnamed pair of riders approach amidst ominous sounds.[6]

In recent years, Dylan in live performance has taken to singing the first verse again at the end of the song. As Michael Gray notes in The Bob Dylan Encyclopedia, "Dylan chooses to end in a way that at once reduces the song's apocalyptic impact and cranks up its emphasis on the artist's own centrality. Repeating the first stanza as the last means Dylan now ends with the words 'None of them along the line/Know what any of it is worth' (and this is sung with a prolonged, dark linger on that word 'worth')."[7]



From the inside of the Season 3 Soundtrack pamphlet thing:
Executive Producer
"However, as the third season finale approached and we began discussing the ways in which we would reveal the four Cylons hiding in plain sight, in the fleet, the idea of a piece of music being the trigger was floated in the writers' room and I rushed to fill the void with "Watchtower." But while it certainly brought a huge smile to my face and filled me with glee at finally being able to use a piece of music I've come to love over the years, it was also a huge throw of the dice. Far from being a background piece that could be written off as a simple head-scratcher, this would put the song firmly in the foreground; it would be elevated to something profound enough to be the actual catalyst by which our characters would both realize their true natures and be drawn to one another simultaneously. It put the integrity of the show squarely on the line and asked the audience to go with us to a strange place that they could easily reject....Like Adama would say, "Sometimes you gotta roll the hard six."

We had a pretty extensive discussion about it on this thread:

Battlestar-Galactica.tribe.net/th...396

I'm in the "the writers just wanted something familiar and not familiar at the same time, and got it when they heard that particular version of Watch tower. It allowed them to hide the theme music at first then pop the lines thought the characters.

And, yes, it's a song about impending doom.