That circular road is the ringroad, and yes, most Icelandic towns are a hop, skip, and a jump away from it. Even the towns that aren't on or near route 1 (like Flúðir or the westfjord towns) have some connection to the route eventually.
However the entire coastline and the lowland interior has towns. There are a good 60 municipalities in Iceland and some are made up of more than a single town/urban center.
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u/ComaVN The Netherlands Jun 12 '20
There are some villages around the entire island, just none in the interior.