Within Ruby on Rails applications database.yml is a plain text file that stores database credentials.
When I deploy my Rails applications I have an after deploy callback
You'll also want to make sure that your SSH system is well secured to prevent people from logging in as your Capistrano bot. I'd suggest restricting access to password-protected key pairs.
Encrypting the .yml file on the server is useless since you have to give the bot the key, which would be stored . . . on the same server. Encrypting it on your machine is probably a good idea. Capistrano can decrypt it before sending.