Because Iceland is a member of the Schengen zone. It's possible to travel between countries in the Schengen area without going through border control (although I don't know about the specifics of travelling to/from Iceland).
Contrast this with Spain's digital nomad program, where they don't require someone to have a powerful passport, all they seem to care about is having a job outside spain.
https://prie.comercio.gob.es/en-us/paginas/teletrabajadores-...