So, during the early middle ages, there was a rather significant production of vaðmál (wadmal) on Iceland as far as I understand, but Iceland is, again as far as my understanding, sort of inhospitable in terms of providing grazing for livestock, so where did they get the wool for making vaðmál? Did they have enough sheep or did they import the wool from somewhere?
That's a strange understanding of Iceland, to be frank. Sheep have always been the main livestock of the island since it was settled in the Viking Age. Even today, there are more sheep living there than people and it's not likely it's a new state of affairs and one of the reasons Iceland was settled in the first place; in the book of settlements (Landnámabók) mentions people settling in highland areas because of the amount of good pasture there. (and it's perhaps worth pointing out the Faroe islands, which are nearby and fairly similar geographically, are literally named the 'sheep islands') Sheep were the agricultural mainstay of insular Scandinavians from Iceland to the Faroes to Gotland, and even the Greenland colony. (and supposedly, some were even brought to Vinland for the temporary stay there)
The Icelanders made use of the whole sheep as well, with sheep's head (Svið) being a rather infamous traditional dish. Even sheep's dung was made use of as fuel on the wood-poor island. (and is still used in traditional smoke-curing of meat)
Vaðmál is not unique to Iceland though, it was traded and used across the Nordic countries in the Middle Ages. Besides in Iceland it was also accepted as a form of payment in Sweden according to several 13th and 14th century laws. (Östgötalagen and Magnus Erikssons landslag)
So the Icelanders had plenty of vaðmál; it was an export good.