This connection was implemeted as IP over X.25 over a satellite link. At the time there were no cables to Iceland and the only way to implement datacircuts was using the X.25 network offered by the goverment/incumbent phone companies running the show.
X.25 was/is notoriously ill suited to transport IP packets and the circut bandwith was only 300-1200 bits/sec. This connection did however benefit the already growing network in Iceland, adding interactive (telnet) and file transfer (FTP) possibilites to the already existing indirect Internet connections (email and Usenet).
This circut was used for just about one year, replaced by a 9600 bit/sec leased line to Stockholm and Internet development in Iceland started.
See also ISNIC - Internet á Íslandi hf. and NORDUnet history.