"This is an exceptional decision. I did not take it lightly, but I believe it is the right thing to do," prosecutor Fatou Bensouda said in a release issued by the court, based in The Hague, Netherlands.
She said several people who may have provided important evidence in the case either died or are too afraid to testify.
The prosecution lost testimony of its key witness "after this witness recanted a crucial part of his evidence and admitted to us that he had accepted bribes," Bensouda said.
Muthaura was accused of crimes against humanity and other offenses allegedly committed in ethnic violence following general elections in 2007. Bensouda said charges in the 2007 election would remain against President-elect Uhuru Kenyatta.
Bensouda said she was disappointed that the Kenyan government didn't provide her office with important evidence and failed to facilitate the access to critical witnesses.
More than 1,100 people were killed, 3,500 injured and as many as 600,000 forcibly displaced in the violence that followed the December 2007 elections.
The ICC said Muthaura was criminally responsible for the alleged crimes as an indirect co-perpetrator alongside Kenyatta, winner of last week's presidential election.
"Let me be absolutely clear on one point -- this decision applies only to Mr. Muthaura. It does not apply to any other case," she said.