The whole Derry/Londonderry thing (we used to call it "stroke city" in Carrickfergus!) isn't quite as simple as it being a Protestant/Catholic thing. The Unionists on the council voted to call the local airport 'Derry City Airport' after all. I think the whole Derry/Londonderry argument tends to be primarily a Belfast based debate, where it is usually a Prod v Catholic thing - but it is too much of a mouthful for most of the locals in Derry who are on the whole happy to refer to it as 'Derry'.
FYI, Derry is what the area was called prior to the Plantations in the 17th Century, derrived from the Irish Gaelic word 'doire', meaning an oak forest. The 'London' prefix was added to appease London merchants who were invited by James VI to set up trade in the town as part of the Plantations.
I think in the census return, it is likely that it meant that your ancestor came from the county as opposed to the city, though it could have been both! Irish placenames are rarely mentioned in Scottish censuses, and in my experience it is usually the county that is named, hence why I suggested looking for your family in the county, as opposed to just in the city.
As for the Derry/Donegal link - tell me about it! I have McLaughlins roaming between the two...!

lol
Chris