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Quoting from the brochure I picked up at Asbyrgi:
"Catastrophic floods of around 4500 - 2000 years ago created the canyon. are caused by volcanic activity under ice caps. Pressure builds up until the water is suddenly released from under the ice, resulting in destructive floods downstream. The volume of water released from Vatnajokull, Iceland's largest icecap, was too great to be contained by the Jokulsa riverbed. This flood spilled north and excavated the canyon, removing lava and basalt deposited during earlier volcanic eruptions." The island in the center was just harder basalt that did not erode.
It was a neat place and the 300 foot cliffs looked like they would support a few nice rock climbs. I kept taking pictures thinking "Mmm, a nice 5.7 there. Over there is an overhung 5.10." If you ever get the chance to go to Iceland, jump on it.
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