I assume you're not represented by a Buyer's Agent and are not using the Colorado Real Estate Contract. If you were using that, there is an appraisal contingency clause in the contract that allows you to notify the seller by an agreed upon date that the home didn't appraise for the sale price. If you notify the seller in writing by that date that the home didn't appraise, the contract allows you go get your earnest money back. However, if you're not working within the confines of that contract, the seller doesn't have to return the earnest money. You also have the option of re-negotiating the price with the seller based on the appraisal. You have this option whether you're working within the confines of the state contract or not. The Seller will likely run into this same situatuion with another buyer, so they may be willing to negotiate.
It sounds like the home is over priced and if you'd been represented by a buyer's agent, which costs you nothing, they would've looked at comparable recent sales and counseled you on what to offer the seller.