A bill was put forward by the minority Pirate Party, which campaigns for internet and data freedom.
It came after the deadly attack the same month against French satirical magazine Charlie Hebdo in Paris.
The bill said it was "essential in a free society that the public can express themselves without fear of punishment".
As three members of the Pirate Party stood before parliament on Thursday, each said: "Je Suis Charlie", an expression used globally to express solidarity with the Charlie Hebdo victims.
After the ruling, the party wrote on its blog (in Icelandic): "Iceland's parliament has now established the important message that freedom will not give in to bloody attacks."
The blasphemy law had been in place since 1940, and anyone found guilty could have been sentenced to a fine or three months in prison.
The Iceland Monitor website said that the Church of Iceland supported the change , and quoted them as saying that "any legislative powers limiting freedom of expression in this way is at variance with modern-day attitudes towards human rights".
The Catholic Church of Iceland, the Pentecostal Church and the Church of Iceland's eastern province opposed the changes.
The Catholic Church wrote in comments submitted after the bill was proposed: "Should freedom of expression go so far as to mean that the identity of a person of faith can be freely insulted, then personal freedom - as individuals or groups - is undermined."
The Icelandic Ethical Humanist Association said that the new law included provisions to ensure that people could still be prosecuted for hate speech.
The Pirate movement was formed in Sweden in 2006 and has since spread to more than 60 countries.
None has seen as much success as the Icelandic branch, which says it is an "international political force fighting for genuine transparency and accountability in government".
In the 2013 election, it gained three MPs for the first time, and polls now say it is the most popular party in Iceland, with the support of 32.4% of the country .
In 2013, its members drafted a law calling for whistleblower Edward Snowden to be granted Icelandic citizenship.
Iceland makes blasphemy legal - BBC News