In Rails, the database folder contains migration files that describe changes to the database structure. First, you generate a migration file which is just a set of instructions. Then you write the schema changes inside it, like creating tables or adding columns. When you run 'rails db:migrate', Rails executes these instructions and updates the actual database. After migration, Rails updates the schema.rb file to reflect the current database structure. You can check migration status to see which migrations have been applied. This process ensures your database matches your app's needs step-by-step.